Hot Off the Web- February 8, 2009

AsianInvestor’s Jame DiBiasio reports that “Pimco rolls out GDP-based bond funds” “The Global Advantage Bond Index, “Gladi” for short, is based on market GDP rather than on capitalisation. The problem with the Lehman AGG, which has been the de facto standard for the past decade, is that the more a sovereign or corporation issues, the bigger its representation in the index – a fact that has often meant a poorly performing benchmark. Japan, for example, has been the biggest issuer of government bonds (at least until now), as it tried to borrow its way out of 13 years of stagnation.” “GDP-weighted approach is intended to provide investors with exposure to high-growth markets that are in the process of liberalizing their capital markets, rather than over-expose them to fiscally imprudent, low-yielding developed-country governments.” (Sounds sensible; one of the problems with capitalization based bond indexing has been that it gives the highest weight to those in most need for credit, rather than a measure of economic success, like GDP.)

Remember 2001 when Goldman Sachs coined BRICs (Brazil, Russia, India and China) acronym designated as an asset class? Well, the Financial Times’ David Oakley reports in “S&P calls for BRICs break-up” that the BRIC’s increasingly divergent outlook no longer supports them being lumped together as an asset class. The outlook of China is the best followed by India, then Brazil and Russia is far behind.

Carla Fried in WSJ’s “What’s so scary about deflation? Read on” quotes deflation expert Gary Shilling that this year we will have deflation. While you may like the idea of cheaper prices, she discusses why deflation if it become more than mild, has led to severe depressions in 1890s and 1930s. Falling prices make consumers and businesses delay purchases (cheaper tomorrow) resulting in falling demand. Your cost of living might decline, but will your standard of living unless you can maintain your income. Borrowing will be cheaper, but “real size of existing debt increases”. Retirees living on investment income will have to move up the risk curve to maintain their standard of living (longer maturity, and riskier, bonds). Historically “mild deflation (0-2.4%) doesn’t doom stocks.”

Sandra Ward interviews Ray Dalio in Barron’s “Recession? No, it’s a D-process, and it will be long”and his message is grim: the D-process will run its course- deleveraging, deflation and depression. The sequence is important, Dalio says, printing of money, deflation, currency devaluation, the gold goes up and long-term rate continue downward because of the need for liquidity. So in the near-term gold and Treasury bonds will be attractive, then in late 2009 and 2010 will be the time to take on equity risk (and China investments due to currency devaluations).

In Financial Times’ “Baltic Dry index up on signs of recovery” Javier Blas writes that the Baltic Dry Index for freight cost of bulk commodities is up 15% in one day (Wednesday) and 98% from last December’s low (though still off almost 90% from last year’s high). Some see this as an encouraging sign of trade in raw materials (and the world economy) driving increased demand in large vessels. (Another 10% increase took place on Friday). However contradictory signs are reported by Evan Ramstad in WSJ’s “South Korean exports take massive hit” that Korean exports, an improvement in which is considered by many a signal of turnaround in the state of the world economy, has dropped 33% in January.

Even though foreign market became highly correlated with U.S. markets and U.S. dollar returns were further damaged by strengthening dollar and commodity price drops some still believe that “Venturing abroad still makes sense for fund investors” . WSJ’s Eleanor Laise reports in the WSJ that some believe that there are opportunities in emerging markets (oversold, currency valuations, compelling demographics), Japan, Korea, Singapore, New Zealand and Australia, and small companies. When you have a choice between selecting a currency hedged and un-hedged fund, try to make sure that you don’t have all your eggs in one basket.

Leslie Scism writes in WSJ’s “Added value- and anxiety- for variable annuity owners” that despite the fact that many thought that high fees made variable annuities a bad deal, many just kept on buying (a total of  22M were sold for $1.4T) because these mostly came with “some sort of guarantee” (like GMWB’s) . Many now are starting to worry if they “got too good a deal” and wonder if the insurers will be able to deliver on the promises. Now worrying about the insurance company, people are thinking about starting the annuity payments earlier (check for company and tax penalties). The explores the various available option depending on the type of contract one may have (“guaranteed minimum income benefit”, guaranteed lifetime withdrawal benefit”, “return of premium death benefit”). Some contracts guaranteed 5-7% annual returns before income start and some had annual ratchets on the base. Very complex issues: insurance company survival (hedged exposure well? watch for downgrades), if company fails will backstops work (bought by another, guarantee association and state insurance), how will income be taxed, etc. (you may want to see your fee only advisor)

WSJ’s Tom Lauricella reports that “New funds for retirees produce less income as bear market bites” . “These managed-payout funds are an attempt by fund companies to get at the current Holy Grail of the investment world: providing hordes of retiring baby boomers with reliable income streams without the high costs and restrictions that accompany guaranteed investments such as annuities.” These managed income funds (e.g. Vanguard’s) were designed to pay out 3-7% of the available rolling average assets in the fund over previous. Most of the funds hit the market in 2008 and thus took a significant hit. Investors are now being told that distributions will drop 15% and by the way they are coming from principal. John Ameriks the Vanguard fund manager still believes that the goal is achievable (especially from this base) because the dividend cuts are “self-correcting mechanisms”. (In the interest of full disclosure, I should add that I also suggested that these are a better approach to lifetime income than fixed or variable annuity schemes for most investors- and I am still sticking to it; variable annuities with guarantees almost always underperform due very high fees, whereas managed income funds will underperform only in extreme stress-Black Swan- circumstances; for annuities you still have questions about the insurance company being able to meet its commitments. The other “self-correcting” aspect of these funds is that the fund manager does rebalancing to insure that asset mix is consistent with the fund objectives- which lead to sell dear and buy cheap pattern.)

In WSJ’s “Markopolos blasts SEC for ‘Financial illiteracy’” Michael Crittenden reports that Markopolos concluded “that the SEC securities’ lawyers if only through their ineptitude and financial illiteracy colluded to maintain large frauds such as the one to which Madoff later confessed.” (By the way the SEC appears to have a far superior record of investigation and enforcement compared to Canada’s fragmented regulatory agencies, so you can imagine what goes undetected, uncorrected and unpunished here.)

And finally, in Globe and Mail’s “Claymore makes ETFs more user friendly”Rob Carrick reports that Claymore funds introduced new features to their ETF line up “to make life easier for the average retail investor”. Specifically they added pre-authorized cash contributions (PACC), dividend re-investment plans (RIP), systematic withdrawal plan (SWP), and they are all free (i.e. included in the current ETF fees. Some of these features, common with mutual funds, were not previously available with ETFs.


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