Hot Off the Web– August 9, 2010

Personal Finance and Investments

In Globe and Mail’s World’s wealthiest playing it safe with investments” Thane Stenner refers to the new World Wealth Report available from Capgemini  in discussing the changes in the way “The financial crisis and subsequent recession has changed the way HNW (defined here as >$1M net worth) individuals think about wealth and investing.” “After riding the roller coaster…it’s no wonder why some people want to get off.” Changes mentioned are: more conservative approach, more hands-on, demanding what-if analysis when getting product or asset allocation recommendations, demanding independent investment advice, “cross-checking” with other sources, demanding transparency and “are less likely to accept what financial institutions, regulators, and analysts say at face value”.

Ted Rechtshaffen in Globe an Mail’s “Mortgage breakage costs: Let’s stop the nonsense”explains how Canadians can calculate the cost of refinancing their existing home to take advantage of lower mortgage rates, and why there is this disconnect between high posted mortgage rates and the actual operational rates.

This week I was referred to a couple interesting articles related to investment management fees. The first (thanks to Larry Elford) from the London Telegraph “7 billion a year skimmed off our savings” and the other (thanks to Ken Kivenko) “Canadians paying more than $10 billion per year as fund fees rise, Morningstar survey finds”. These articles don’t mince words about punishing fees that (UK and Canadian) investors have to contend with in their effort to build a retirement nest egg. The Financial Times’ Pauline Skypala also weighs in on the topic of fees in “A lot of indignation but no change on fees” and suggests that “It is only in raging bull markets that investors can afford to take the view that net of fee returns are all that matters”. (Why are people still buying these mutual funds when broad market exposure can be gained with ETFs at 1/10th of the cost? Beats me!)

I came across this week a shocking,  must see, video available at  Breach of Trust(it’s about an hour long in eight segments) by ex-financial industry insider Larry Elford who in addition discussing the corrosive impact of high mutual fund management fees, average investors naiveté in confusing salespersons with advisors, and requirement for a buyer beware approach to investing, he also tackles the even less known and more murky aspects of the financial services industry in Canada like the  ”code of silence vs. code of ethics”, “failed self regulatory regime based on the honour system” and “predatory and unprofessional practices”.

Jason Zweig in WSJ’s “Will online financial planning catch on?” looks at a couple of websites offering online financial advice using a combination of tool based with/without human assisted approaches to financial planning: Veritat Advisors and People’s Financial Advisor. The business opportunity is presented as: the U.S. needs 550,000 advisers but the are only 62,000 certified financial planners, cost of human planners is $150+/hour and $3,500+/financial plan; so these online services are intended to address both the lack of planning resources and accessibility due to willingness/ability to pay for the service. (It’s the good old ostrich policy people are not prepared to write a check for a financial plan, but if they have no problem paying $5,000 invisible fees on a $200,000 portfolio invested in mutual funds with 2.5% MERs.) Zweig says that in the past the automated services failed to take off, but perhaps these new attempts combining automation with customization and some human touch might have better uptake.

In the Globe and Mail’s “When investors and advisers don’t see eye-to-eye”Tom Bradley discusses the situation an advisor faces when “he doesn’t agree with a client’s strong view” and often “investors don’t always get what they pay for. In a challenging situation like this, advisers too often provide little resistance, making it easy for clients to go with their emotions”. The business risk to the advisor to push back hard is too great. Bradley suggests that advisor and client consider the question “what the adviser is doing on his own account?”

Jonathan Chevreau in the Financial Post’s “Reverse mortgage no panacea” tells readers about some of the problems with reverse mortgages and alternatives to consider: asset lost to estate, expensive, line of credit might be cheaper, downsizing lifestyle. (You might also be interested to read one of my old blogs on the subject at   Reverse Mortgages)

Real Estate

Steve Ladurantaye reports in the Globe and Mail on “Shaky days in the housing market” in Canada. He specifically looks at some of the metrics watched by economists to get a sense of the direction of the real estate market. These metrics include: composite home price indexes (with 1990 at 100, Canada is at 194 vs. U.S. at 145), home ownership costs as a percent of household income (33-46%), months of inventory, average house price deviation from fair value (+14%). In a related story Ladurantaye reports that “Condo sales in Toronto drop for the first time in 16 years”.

Kelly Green looks at CCRCs and their risks in WSJ’s “Continuing-care retirement communities: Weighing the risk”. These CCRCs generally require a large entry fee (average of about $250,000 sometimes refundable in part or whole) and monthly fees depending on the level of care requires by the individual (independent-living, assisted living and nursing care). If the CCRC goes into bankruptcy protection people can lose their entry-fees and the terms of their ongoing stay could change. While CCRCs “promise to alleviate one of the biggest worries facing families with aging loved ones: how to secure, and in many cases pay for, future long-term care” readers are advised to do extensive due diligence on the prospective community’s financial state before signing up.

Bloomberg Businessweek’s Vanessa Wong in “America’s strongest housing markets”looks at some optimistic forecasts indicating strong housing recovery by 2014. The article includes 2014 projected strongest market in each state. (Interesting to flip through the cities mentioned so long as we remember that “forecasting is difficult especially about the future”.)

In Herald Tribune’s “A double-dip in region’s housing market grows likely” Tom Bayles reports on concerns about a real estate double-dip in Southwest Florida. Bayles (personally “upside-down”, i.e. mortgage larger than the value of his house) enumerates reasons why double-dip is likely.


In the Toronto Star’s “Workers in big pension plans could soon face cuts in benefits”Tony Van Alphen reports that “Canada’s biggest multi-employer pension plan says thousands of members could soon face future benefit cuts of 15 to 50 per cent depending on negotiations with companies.” (Thanks for article to Dan Braniff) Potentially, benefits of almost 300,000 are affected. (Unlike defined benefit plans (like Nortel’s where the employer guarantees and Canada’s regulatory framework is supposed to protect a specified benefit level), this multi employer pension plan (MEPP) is a target benefit plan. In such a target benefit plan employer plan contributions are fixed (and with additional member contributions) so that some actuarially expected pension can be delivered to participants; however market risk is born by plan members requiring them to increase their contributions or try to negotiate additional employer contributions. (By the way CPP is also a target benefit plan and benefits/contributions can be decreased/increased if necessary, as it happened in the early 90s). The advantage of these MEPPs (typically co-administered by employers and unions) over typical (single employer) defined contribution plans is that assets of a large number of employers are pooled and then professionally managed at lower cost. One of the disadvantages is the implicit intergenerational transfers that take place due to market volatility as in this case: active member have to increase contributions, inactive members <50 years old will take a hit on future pension benefits, but for inactives if >50 years old and those already on pension future pensions are unaffected (for now). (My preference for such plans would preserve the advantages of payroll deduction and pooled management but be structured so that individual accounts with individually selectable risk (asset allocation) and contribution levels would be permitted; on retirement income would be generated by a combination of compulsory longevity insurance coupled with a systematic withdrawal strategy.)

In NYT’s “Battle looms over huge cost of public pensions” Ron Lieber suggests that “There’s a class war coming to the world of government pensions. The haves are retirees who were once state or municipal workers. Their seemingly guaranteed and ever-escalating monthly pension benefits are breaking budgets nationwide. The have-nots are taxpayers who don’t have generous pensions.” He quotes a study which estimates that there is “$1 Trillion gap as of fiscal 2008 between what states had promised workers in the way of retiree pension, healthcare and other benefits and the money they currently had to pay for it all.” A more detailed view of this problem is given in Weitzman and Bullock’s “America: States of Distress” in the Financial Times.

Things to Ponder

The Financial Times points to “A new methodology to find genuine alpha creators”. Shahin Shojai writes that “This method of performance evaluation should be incorporated into the managers’ annual compensation models. Along with receiving a percentage of assets under management and charging trading fees, a proportion of their compensation should come from whether they were able to beat their own totally inactive portfolio during the year.” The author indicates that this methodology “not only helps determine genuine alpha; it also protects clients from trading-happy managers. More important, it is something all private and institutional clients can compute with a simple calculator.” The Economist’s Buttonwood column has a related story entitled “Time to reassess how fund managers are rewarded”. (Sounds like it’s worth a try.)

In Globe and Mail’s “Why you should diversify by sector, not region”Simon Avery argues that globalization has led to very high correlation between markets of regions/countries and that geographical diversification should be replaced by sector diversification. While country/regional correlations are typically >0.9, correlation among some sectors is still in the 0.75 area. The S&P report quoted indicates that “The capacity to over- and under-weight individual sectors potentially offers the ability to outperform broad regional indices in both up and down markets”.

In “How to beat deflation” Kim and Laise point to “ominous” deflation signals (e.g. falling inflation, rising bond prices) and suggest that Japan-like deflationary period is possible. Ways to hedge against the deflationary risk listed include: consumer staples rather than financial stocks, long term government strips (yields on 10 year treasuries might drop from 2.83% to 2%, while TIPS could fall in value), gold (government response to deflation is usually to print money, which stokes inflation fears), cash is king and “deflation isn’t kind to debtors”. You might also be interested in reading the related Financial Post story “The great debate: Stocks or Bonds”in which James Saft argues that the recent “remarkable earnings season in the U.S.” is unsustainable in light “anaemic economic growth”, rising savings and threat of deflation. He suggests that stock prices will be heading down and bond prices up.

Paul Davidson in USA Today’s “Some manufacturing heads back to USA” writes that “There are myriad reasons for the shifts, often called “onshoring” or “reshoring.” Chinese wages and shipping costs have risen sharply in the past few years while U.S. salaries have stayed flat, or in some cases, fallen in the recession. Meanwhile, U.S. manufacturers have been frustrated by the sometimes poor quality of goods made by foreign contractors, theft of their intellectual property and long product-delivery cycles that make them less responsive to customer demand.”  (Wow what a surprise, the question is whether Humpty can be put together again?)

In WSJ’s “Legacy of the ‘Flash Crash’: Enduring worries of repeat” Lauricella and Patterson recap the May 6th“flash crash” and conclude with “New circuit breakers, now in pilot mode, require a five-minute trading halt on S&P 500 stocks that move more than 10% within five minutes. These “collars” could help keep prices from suddenly cascading. But some forces behind the flash crash seem beyond the reach of regulators. Exchanges are unlikely to be able to prevent high-frequency trading firms or statistical-arbitrage firms from bailing out of the market en masse. The challenge for regulators and exchange operators is whether they can find ways to protect investors in a market ever-more defined by high-speed trading. It may be that such a market is inherently vulnerable to high-speed crashes.”

Edward Chancellor writes in the Financial Times’ “How states nurture bubbles and strife”that “Bankers have deservedly taken most of the blame for the global financial crisis. But this has conveniently diverted the spotlight from the role of the authorities in the latest fiasco.” The article discusses the government’s role in creating bubbles with examples like: SEC failed to control Wall Street, Fannie and Freddie’s role in the housing bubble, low interest rates that “fuelled the real estate bubble”. What’s worse is that the new regulations are unlikely to prevent future crises as “Market practitioners invariably find ways to evade the safeguards put in place after previous busts.”

Clarida and El-Arian in the Financial Times’  “Uncertainty changing investment landscape” talk about “unusual uncertainty reflects the disruptive combination of deleveraging, reregulation, structural unemployment, and other ongoing structural changes.” They then go on to list some of the implications: “mean reversion” based investing is out, volatility due fluctuating investor sentiment is in, tail hedging is in, “historical benchmarks and correlations will be challenged”, and less available credit to sustain leverage will reduce valuations. (Thanks to Victor P. for bringing article to my attention. Difficult to disagree with the broad points (lower demand for volatile assets, increased volatility, more desire for tail-hedging, new benchmarks perhaps returns>some minimum or zero or inflation or inflation plus 2% reflecting lower expectation, and lower valuations) in the article in general, and specifically that the traditional bell-shaped expectations (with or without fat tails) in market returns or prognosticators’ opinions are out. But then as I’ve said earlier “forecasting is difficult, especially about the future”; so who knows what the world will look like in 1-2 years, never mind in 10 years.)

And finally, in WSJ’s “Dual role in housing deals puts spotlight on Deutsche” focus shifts from Goldman to Deutsche indicating that “Federal probes of the collapsed mortgage-bond boom are shedding light on how Wall Street firms sometimes created securities and sold them to one set of investors, while advising others to bet against them.” (No doubt Goldman was not alone; it just was more successful in executing standard Wall Street practices. I suspect more fines on are coming to Wall Street.)


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