blog08mar2009

Hot Off the Web- March 8, 2009 Tom Lauricella discusses problems with target-date funds in WSJ’s “For retirement, ‘One size’ isn’t always a good fit” . First of all they are not all the same; they use different levels of asset allocations (not just stock/bond mix, but also for example domestic/international) as retirement date approaches. Secondly, unlike some education savings accounts which give you the option to choose not just the start drawing funds retirement or college start) date, but also a risk level (conservative, moderate and aggressive), with target date retirement funds you can only chose retirement date. As usual not everyone agrees that the dimension of risk needs to be added; some suggest that those who are more/less risk tolerant then average can simply choose a later/earlier than planned retirement date in selecting the target-date as a way to increase/decrease portfolio risk.

WSJ’s Jason Zweig suggests some constructive steps that you can take despite these crazy times in “Tempest-tossed? Take some control” : inventory assets, upgrade (sell expensive losing funds to lock in capital loses and invest in cheaper versions of the same asset class), redirect future tax-deferred contribution and dividends to investment grade bond or money market funds, if you can’t sleep at night sell down slowly instead of selling everything at once, pay off debts with stock sales, and make you cash work using 5 year FDIC insured CDs (especially if you can place them in a tax-deferred account) available now at 4.5% even though inflation is near zero(or GICs for Canadians).

Tim Cestnick has an interesting article in the Globe and Mail entitled “Avoid naming RRSP beneficiary in your will” . In it he discusses various approaches on how to name RRSP beneficiaries (not in your will). A scenario that you might find interesting is when taxes are due upon death, the RRSP beneficiary still receives the full value before any taxes are deducted, and the taxes due are “paid out the remaining assets of the estate, if there are sufficient assets to pay the taxes.” Therefore the beneficiaries of the assets outside of the RRSP may receive less than you intended to leave them. There are some other potential outcomes as well. You’ll probably also want to read Tim Cestnick’s previous week’s article in the Globe “Choose your RRSP beneficiaries carefully” , where he discusses who you should/could name as beneficiaries of your RRSP and the corresponding tax implications. (Spouse and dependent infirm child of any age then assets transferrable without initial tax directly to their RRSPs; similarly taxes may be deferred when asset transferred to minor children only via an annuity to age 18.)

The Financial Times’ “Investment and crisis: an error-laden machine” John Plender discusses how just as all global equity gains since Asian crisis of ’97-’98 were erased and with it, complex structured credit product damaged insurance companies, hedge funds didn’t do a great job hedging, most of private equity investment in the past three years will be wiped out, and endowments and foundations have not done much better with their large alternative asset class investments. Plunder blames ““disaster myopia”- the tendency to underestimate the probability of disastrous outcomes”. Even Warren Buffett fell victim of it. “The problems of disaster myopia, poor modeling, mismanaged diversification and excessive reliance on rating agencies stem more from failures of judgment by consultants, investment committees and pension fund trustees than systemic flaws.” He closes off with some sober advice “so despite the complexity of today’s markets, the lessons in all this are oddly homespun. Mathematical models should not be relied on without a proper understanding of the economic conditions and behaviour that fed them. It is foolish to put blind faith in credit rating agencies. Do not invest in what you cannot understand. Shun arbitrage strategies that assume permanent access to liquidity. Avoid investment vehicles that inflict swingeing charges in exchange for what in most cases will amount to market performance or worse. Treat leverage with due care. Recognize that the conventional wisdom of the consulting fraternity is not conducive to contrarian behaviour, one of the keys to successful investing. Above all, beware what Charles Mackay, the 19th-century historian, called the madness of crowds.”

In “How to really diversify your portfolio” Financial Post’s Jonathan Chevreau, reminds readers that global diversification didn’t work in this market crisis (though I think it actually worked to some degree, because if you really diversified your portfolio geographically by buying ETFs which do not  hedge the currency risk, then you realize the diversification benefits as the Canadian dollar fell relative to the U.S. dollar.) because of in global crisis world market become highly correlated. The same was true of alternative asset classes (like hedge funds, private equity, etc); in fact due to lack of liquidity in some of the alternative asset classes, there is also likely a delay in full recognition of the drop in value. Chevreau quotes Richard Kirby who advocates the use of hedging with options strategies to protect portfolios; he then correctly adds that a financial advisor may be required because “doing it on one’s own could lead to disaster.” (Unfortunately, he then suggests vendor-manufactured products like index-linked GICs, variable annuities, guaranteed minimum withdrawal benefit products which will give you very little if any upside. Personally, I’d be inclined to use laddered bonds or GICs in the portfolio instead of those manufactured products.)

Brett Arends in WSJ’s “Has fear blinded investors to value?” challenges “efficient market hypothesis” and asks if we are really instead dealing with “efficient market hypnosis”? “This is where the market simply lulls us into submission by constant repetition. You can’t fight the tape. If a perfectly good stock has fallen 40% in value, then, by golly, efficient market hypnosis makes us think there must be an excellent reason for it.” And, do you remember the dotcom mania? He also mentioned examples of many market prognosticators who warned about the coming collapse, only to watch steady increases in the market for months! (Interesting questions, which just show you how hard it is to time the market; perhaps the sensible thing to do is still continue to with the strategic asset allocation compatible with your risk tolerance- and if you insist in trying to “add value”, do it at the margin by fine tuning a little with a tactical asset allocation. This could be implemented with core-satellite approach to your portfolio.) By the way the Economist also has an article this week on efficient market theory (which by the way is defined as “the idea that asset prices accurately reflect all available information” entitled “The grand illusion”. On the same topic in Jonathan Chevreau’s Financial Post article “The pendulum never stops in the middle”he quotes Dan Richards that markets “from periods of outlandishly elevated valuations to ridiculously beaten down levels, from periods of unquestioning euphoria to absolute pessimism”; and that you can only count on efficient markets in the long run. Therefore major overshoot on the downside is just as likely as major overshoot on the upside. Clearly lots of questions about the efficient market hypothesis in many people’s minds.

Jason Zweig’s WSJ piece “Rebalancing your portfolio can be a tough ride” questions heretically the value of rebalancing with specific periods when rebalancing failed such 1929-1932, 1993-2002. Still his advice is for young individuals to rebalance but not more often than once a year (some even suggest significantly less frequently or using asset rather than time based triggers). He says that however for retirees “rebalancing into stocks could hurt more than it may help”. The value of rebalancing on your “portfolio depends not only on what the markets do but also how they do it”. (He will no doubt get lots of mail on this topic.)

The Globe and Mail’s Janet Mcfarland in “GM pensions: who is responsible?” searches for the guilty parties responsible for the significantly underfunded GM pension plan. This together with impending(?) bankruptcy of GM may lead to massive damage to GM pensioners. (This sounds like a story that I heard before-Nortel?) The CAW thinks the blame is shared by the Ontario government and GM; no doubt that they have a significant share of the blame, but they could not have done it without quiet acquiescence of professionals (actuaries, trustees, investment managers) who should have known better!

And finally, In the ‘believe it not story’ of the week in Financial Post’s “Nortel pays big bonuses to keep execs” Bert Hill reports that Nortel is asking the Court for permission to pay $45M bonuses over the next 12-18 months, with over 90% going to 1000 executives (about 3% of the employees) and half going to 100 executives. Meanwhile recently laid off employees get no severance, 3200 more will be laid off shortly, pensioners already stopped receiving parts of their pensions and are risk losing perhaps 40% or more of their pensions. How do you wean pigs away from the trough?

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