Steven Chase quotes TD chief economist Drumond in the Globe and Mail’s “We face small pensions unless savings boosted”, that “Canadians should be forced to save more for retirement because their RRSPs and private-sector pension plans are in tatters, a leading economist said yesterday.” He predicts that not just DB pension plans (other than civil servants) but even DC plans with matching employer contributions will be increasingly scarce and that “We’re going to have a lot of Canadians with shattered dreams when they come to their retirement. They’re going to suffer an unexpected drop in their income,… After 50 years of promoting RRSPs, we have to conclude they haven’t turned out as envisioned. I don’t know why we don’t just recognize this and make the needed adjustments to the retirement income system”. (Also see my new blog on commenting on Jack Mintz’s FP article of April 21, 2009 entitled “Jack Mintz: Beware of the super pension fund” -NOT; Mr. Mintz appears to think that the Canada’s pension system just needs minor tweaks and all will be good.)
Eleanor Laise’s “Odds-on imperfection: Monte Carlo simulation tools” in the WSJ discusses the flaws of Monte Carlo methods in that they failed to predict the recent market slide, because “they often assign minuscule odds to extreme market events. Yet these extreme events seem to be happening more often.” The solution proposed by some is to introduce fat-tailed distributions instead of the widely used Normal (Bell-shaped) distribution; also some advise using larger number of simulation runs perhaps 10K-100K rather that 1K-10K. As the old saying goes GI-GO (Garbage-in garbage-out); the tool works as intended but if the input data is garbage, the output will be as well. Remember that the inputs are supposed to reflect the future returns, inflation, volatility and correlation; and as the other saying goes “predictions are difficult, especially about the future”. You should also recall in an earlier blog where I discussed Jim Richmond’s flexibleRetiremenPlanner that “This is a must try tool if you are exploring retirement planning scenarios. But do keep in mind the great mathematician Richard Hamming’s admonition that “The purpose of computing is insight, not numbers.”“ If you are looking for the impact of extreme events (like last year’s 40-60% drop in many asset classes, you might consider a stress-test approach to your portfolio; specifically look at your ability (and willingness) to tolerate portfolio losses associated with your asset allocation when one or more asset classes in your portfolio hit the low end of their expected ranges individually or simultaneously. This won’t say much about the probability of occurrence, but will certainly give you a sense of the impact of such an occurrence.
Church and McFarland write in Globe and Mail’s “How a good plan went bad” about the disastrous results that University of Toronto Asset Management has experienced by trying to (poorly) imitate the Yale endowment investment strategy (i.e. light on traditional assets like stocks and bonds, and heavy on alternative asset classes like hedge funds). UTAM appears to have made every mistake in the book: currency speculation, high transaction fees, fund of funds approach to hedge funds (with fees piled on top of fees- not quite the Yale model). UTAM lost 29.5% last year which no doubt will have massive impact on the university in the coming years.
Jonathan Chevreau writes in the Financial Post that ”Loonie hedge may be wise” . To be fair, he presents pros and cons to partial, full and no hedging options by Canadians for their U.S. and international investment exposures. He quotes people who argue for hedging U.S. but not international exposures, another argues that since you don’t really know the direction of exchange rates perhaps you should hedge 50% of your non-Canadian exposure, and the still another argues that for the long term investor there is no need for hedging currencies. (In fact broad currency exposure could be another form of diversification. What wasn’t mentioned that a decision to hedge is a form of speculation, since you don’t really know the direction of exchange rates, however if you have foreign currency liabilities-e.g. you are a snowbird who spends 4-5 months a year in the U.S. you may want to hedge those liabilities with U.S. dollar investments/income. You might also be interested in reading my earlier blog on Hedging of Foreign Currency exposure )
Dennis Butler in the Financial Times’ “In for the long haul”argues that you should not listen to those who advocate that you should abandon “buy-and-hold” and pursue active trading strategies. “Today, there is reason for optimism about long-term investing. On a rolling, ten-year basis, prices now are more depressed than at any time since 1974. Historically, a period of weak ten-year returns has been a good time to buy stocks. With valuations on a normalised basis far more attractive than one or two years ago, the present climate for investing in stocks is especially attractive for those whose investment discipline has left them with ample cash.”
The Financial Times’ John Authers has an interesting article on “The heavy cost of the principal-agent divide” . He discusses the effect of the growing use of various financial intermediaries. Examples include: your mortgage lender does not bear the risk that you won’t make payment- instead the mortgage is securitized, 30 years ago individuals owned 75% of U.S. company shares directly-over time mutual funds became intermediaries, then hedge funds which controlled 3% of global equities ended up with 30-40% of daily trading on Wall Street. The more recent shift to index funds, while sensible for individuals, Authers argues that it created a situation where the investor has no interest in the behaviour of management. “So the growth of indexation has weakened the control shareholders exert over companies’ managements. That in turn allowed managers to behave more and more as though they owned the companies….Thus it begins to look, as though the gradual split of principals from agents at all levels of finance has been a big factor in the financial disaster of the past two years.”
John Keefe’s Financial Times article “The search for the right products goes on” discusses the various types of retirement focused products, with so far limited uptake that try to meet the need of “investing to create maximum income at an acceptable level of risk – how to safely spend down principal.” The available products from the mutual fund industry are typically: target date funds, “self-liquidating (over 10, 20 or 30 years) managed payout funds” and “endowment accounts where the manager attempts to grow principal over time”; these come without guarantees. Insurance companies offer immediate and deferred fixed and variable annuities (variable annuities are a very expensive means of offering equity market return participation to annuity buyers); more recently insurance companies have added features like minimum income guarantees. He quotes Vanguard’s Utkus who argues that perhaps “What may come out of this is a simple solution: an inflation-indexed annuity for protection of a capital base, plus a mutual fund portfolio for some growth. The big obstacle is that people don’t want to part with their capital.” (The author forgot to discuss the option of Longevity Insurance, which overcomes investor/retirees’ need to lose control of the capital.)
Pauline Skypala writes in the Financial Times’ about “Multi-challenges for asset managers”. In the context of banks appearing to (want to) divest of their asset management subsidiaries, Skypala discusses how the long-only asset management industry is contracting as investors are taking “the barbell approach…dividing assets between passive strategies and high risk, high return products.” Another trend mentioned is the growing demand for recommendations on the “optimal” global asset allocation. “It is difficult to get clients to pay for advice. Investors “aren’t happy writing a cheque for advice but are relaxed about paying for asset management,” quoting Mr Parker. Other interesting predictions mentioned are that “most financial markets firms will become “beta transactors”, by which it means “utilities that provide the infrastructure required to facilitate capital allocation”. “Others will provide advice, while a handful of “alpha seekers” (hedge funds, private equity firms and boutique investment houses) will be in the high risk/high return business. “
Jonathan Chevreau in Financial Post’s “A complete financial plan in 140 characters” does a pretty good job at the Twitter version of financial planning : “Eliminate debt. Cut up plastic. Join pension. Buy home. Pay it off. Spend little. Save tons. Invest wisely. Be tax smart. Marry for life.” And his revised one “Lose debt. Join pension. Own home. Spend little. Save tons. Invest wisely. Be tax wise. Marry 4 life. Insure life. Make will.”
The Financial Times’ Gill Wadsworth in “Is there a market for downside protection” discusses the arrival of downside protection products from HSBC Global Asset management which use CPPI (constant proportion portfolio insurance) to protect against losses. CPPI adjusts your risky assets dynamically to stay at a constant proportion of your assets above some minimum floor ; once assets drop to floor value, you are out of risky assets. “CPPI works by investing in protection and performance assets that are rebalanced on a dynamic basis depending on market performance. The protection assets consist of cash and fixed income instruments and HSBC claims that if the fund is held to maturity investors will receive 100 per cent of the value of contributions made, plus 100 per cent of any investment gain achieved from equities.” Numerous critics argue that it is too little too late, why pay for protection if stocks are expected to outperform over the long term (especially from a low base after a market crash), 1% is too high a cost to pay for the protection and there is counter-party risk. (One might argue that fairly priced downside protection would be attractive as one approached retirement, to protect against a significant market drop necessitating delayed retirement or significant drop in retirement income. Nevertheless, buying downside protection today may feel a little like closing the barn door after the horses are gone?!?)
WSJ’s Karen Blumenthal lists “Five money lessons for new college grads”. These are: (1) importance of emergency reserves, (2) look at fine print in all contracts (especially how much does it cost to get out of the contract) instead of hitting “I Accept” button, (3) focus on total cost, not monthly payments, (4) borrowing for home or education is OK, but not consumer debt, and (5) watch out for your permanent record (credit scores).
And finally, consider Jeffrey Robinson’s Barron’s article “You have got mail—from Nigeria” a warning. If it sounds too good to be true, it probably is! The essence of the latest Nigerian scam is that you help clear payment due to their company, and you will receive a check for several thousands of dollars of which you forward to the company 90%. The only problem is that the check you’ll receive and is processed by your bank will bounce shortly after the company receives your (good) check for 90% of the amount. And surprise, my email arrived shortly after the article appeared in Barron’s. Here it is:
I am Mr RON.Manager Of Rjs Interiors.We need a representative from USA /CANADA/PR who can be working for us as a Payment Officer.we receive Payments from clients in form of Money Orders and Check for which its always too expensive and stressful for me to come down and receive such payment so We decided to contact you.As a Payment Officer for the company all you have to do are below:
*. Recieve Documents/Payments in form of Check, Money Order *. Deduct 10% which will be your percentage *. Forward balance after deduction of percentage to the company.”