Hot Off the Web– May 9, 2011

Personal Finance and Investments

In the Globe and Mail’s “It’s in your interest to know the deduction rules for borrowing”Tin Cestnick takes the reader through the rules, for making sure that interest is deductible, such as: “borrowed money used to earn income from a business, or property. Income from “property” includes interest income, dividends, rents and royalties”, pure capital gains don’t qualify but common shares qualify because you eventually expect both capital gains and dividends, borrowing to generate income but not profit, you are permitted to restructure your affairs to transform non-deductible into deductible interest, and others.

Ted Rechtshaffen in the Globe and Mail’s “Do you have the ‘green light’ to retire?” writes that according to a recent survey, as many people returned to work from retirement for financial as for non-financial reasons; that is why “you need to look at both the financial planning and lifestyle/relationship issues – before making the retirement decision… financial ability only suggests you can retire. It doesn’t suggest you should retire.”

In the Financial Post’s “Singles, couples face own retirement issues”Linda Stern looks at the different challenges faced by single and couples in retirement planning, like: different life expectancies (male, female, joint), cost of living (single is 75% of couple), need for institutional care (lower for couple who can take care of each other, but single person could sell home to spend on care), and others.

In the Financial Times, Andrew Greene looks at how “Mutual funds search for new landscape”. Challenged by the explosive growth of passively managed ETFs, the new landscape approaches include:  “Absolute return and hedge-like funds have been multiplying because they answer retail investors’ desire for downside risk protection and uncorrelated returns”, tactical asset allocation funds, and target-date funds. U.S. money managers are also eyeing fast growing overseas markets where rapidly growing middle class is amassing significant assets that they could tap into for a new source of management fees. “The hurdle for active managers is outperforming benchmarks after fees in a way that is characteristically different than the index.” (Good luck to those who rely on active management.)

This past week, the Financial Times also had numerous articles on structured products (e.g. Matthew Vincent’s “Sales soaring high despite regulatory concerns”). The articles discuss growing retail sales of products like: principal protected notes, reverse convertibles, etc. The structured products were found by regulators to have come with “unsuitable or unclear” advice. (GMWBs can be considered structured products as well. Structured products are mostly opaque, complex, and very expensive; when somebody tries to sell me a structured product, I tend to run the other way.)

Gillian Tett in the Financial Times’ “Why ETFs give an uneasy sense of déjà vu” writes that it’s not surprising that European regulators are starting to get worried about ETFs. What started out as a beneficial product enabling portfolio diversification by passive approaches to access to different asset classes with high level of transparency and at a very low cost, has now been extended to include ”synthetic ETFs, which use derivatives or structured products…(which) account for 45% of the market in Europe. And some ETFs are now using leverage, others are starting to purchase riskier assets such as risky loans.” The concerns associated with these new flavours of ETFs range from: retail investors not fully understanding their complexity/risk, “liquidity mismatches and poor collateral practices” as well as “potential conflicts of interest because of “the dual role of some banks as ETF provider and derivative counterparty”, and contributed to recent commodity price run ups. (Personally, I stay away from exotic ETFs, and use almost exclusively low cost passive implementations of broad market indexes.)

In Journal of Financial Planning’s “Keeping ahead of the long-term care domino” Jim Grote looks at Long Term Care Insurance requirements and options and he provides a pretty good overview of the options, though a less convincing argument about the requirement/benefit of LTCI. On the need for LTCI,  the author quotes the (somewhat conflicted) executive director of the American Association for Long-Term Care Insurance who suggests that LTCI is necessary to prevent the “financial planner’s potential loss of income assuming clients over age 65 draw down assets under management to pay for five years of long-term care. He notes that 40 percent of people over 65 will need two or more years of long-term care with half of those needing care for more than five years.” (The source is an industry advocate, and the argument, that this is good for the financial planner rather than prospective LTCI customer, is a far from convincing argument. You might also be interested in reading my take on LTCI in   LTCI-I Long-Term Care Insurance- An Overview and LTCI-II: A Quantitative View)

In WSJ MarketWatch’s “Holding TIPS will make you poorer”Brett Arends writes that short term TIPS are now priced yield -0.5% and the CPI which drives its face value adjustment is a “manipulated statistic…for most people, day-to-day costs are rising much faster than the official CPI”.

Real Estate

Florida’s snowbirds are about to be shafted even worse if voters pass the constitutional amendment just passed by Florida’s legislature. In the Miami Herald’s “Voters to get chance to lower property taxes again” Mary Ellen Clas discusses the just passed Bill 381 and quotes a(n honest and perceptive) Florida House representative saying that “We are compounding the inequity that exists in our tax laws’’. Realtors, forever promoters, “believe that the measure will help market Florida residential and commercial property to out-of-state investors…but cities and counties…fear the concept will strip them of the money needed to finance their already struggling budgets”. The Bill comes with a 2023 sunset clause. Florida’s voters will have a chance to give the thumbs up or down on this constitutional amendment in November 2012. (Nonhomesteaders would be mistaken to believe that a reduction of the cap on tax value from 10% to 5% will benefit them; with this Bill they will continue to bear not just the current unfair but additionally an increasingly larger share of the tax load! See my in-depth look at this new Bill at Florida’s nonhomesteader snowbirds shafted again by new property tax Bill 381)

The Palm Beach County “Property appraiser says home value plunge appears to be levelling off”. Adam Playford in this Palm Beach Post article writes that PBC property appraiser’s “estimates show a countywide loss of 1.5 percent to 2 percent. As recently as January, Nikolits was predicting a 5 percent fall, on top of 10 percent drops in both 2009 and 2008” That means that  taxable value of properties are expected to stay flat in the upcoming tax year; good news for taxing authorities, but bad news (and getting worse news see previous article above) for Florida’s non-homesteaded property taxpayers. However “Nikolits’ numbers are far rosier than those used by Realtors, however. Bill Richardson, the president of the Realtors Association of the Palm Beaches, called the property appraiser’s numbers “absolutely ludicrous.” His association’s data shows the median sales price dropping 11.8 percent in 2010”.

In the Financial Post’s “Don’t be tempted by U.S. fire sale”Garry Marr discusses how Canadians, tempted by the weak U.S. dollar and fallen real estate prices to plunge into U.S. property, often extract equity from their appreciated Canadian home. Marr discusses the numerous risks; not a recommended action.

The Globe and Mail’s “Mortgage changes you need to know” and “Rule changes make mortgages a moving target”discuss recent changes for eligibility to government insured mortgages together with their potential impact. Some of the changes mentioned include: reduction of amortization period from 35 to 30 years for LTV ratios greater than 80%, refinancing limits reduced from 90% to 85% and the ineligibility of non-amortizing equity lines of credit. (Recommended by Rob Carrick’s Personal Finance Reader)

And Steve Ladurantaye writes in the Globe and Mail’s “Competition Bureau asked to settle new fight over MLS listing”that “A fresh fight is brewing in the home sales industry, as the associations that represent real estate agents try to enforce restrictions on new, lower-cost competitors in an effort to prevent them from doing business across provincial boundaries.”

Pensions

In the Financial Times’ “Bean counters ignored over discount rates”Pauline Skypala reports on the “arcane topic” of discount rates which “are key to determining how much members and employers need to pay into schemes. The rate used is effectively the return needed to ensure the pensions that have been promised can be paid. (Yes, you read that correctly, and if this sounds insane, it is because it is insane, as I’ve railing against these practices in private sector DB plans.) The higher the rate, the lower the cost of providing pensions appears to be”. Experts have been arguing that “the discount rate should be based on the yield on long-dated index-linked gilts, and because public sector pensions are inflation-linked and guaranteed by the government (e.g. currently 0.76% for 2035 index linked bonds). Instead the government settled on 3% the expected GDP growth rate (i.e. an improvement over previous practices but still not good enough.) The real concern is over “the unfairness the government decision will perpetuate. Public servants will continue to enjoy “the best type of pension”, while private sector workers will have to make do with defined contribution schemes, which he believes will bring “huge disappointment, anger, poverty and taxpayer-burden”. The government has opted for political expediency over transparency and fairness, he concludes.”

In WSJ Market Watch’s “Nortel units seek over $10B from parent” Peg Brickley writes that “If the Nortel European claims survive court tests, unsecured creditors of the Canadian parent will see a significant reduction in the amounts they will receive, Ernst & Young said…European units slapped the Canadian parent company with claims for a variety of alleged wrongs, including unpaid loans, customer revenue not received and pensions left unfunded…the aggregate amount of quantified claims European Nortel units filed in the Canadian case tops $14 billion…If the European claims aren’t decided quickly, the Nortel European units could succeed in tying up the company’s cash pending a resolution. That means no one will get paid out of the Canadian case until the courts have ruled on the litany of various alleged wrongs listed in the European unit claims”. Those gluttons for punishment may read the complete April 28, 2011 E&Y Monitor’s Report on the subject. On the same topic the Toronto Star’s “Court approves Google’s bid for Nortel’s assets” concludes with the ominous sentence “It’s also unlikely that Nortel pensioners in Canada who have fought the company over the windup of their pension plan will get any of the money raised from the asset sales.”(Pathetic, but to expect anything better, based on the various decisions/outcomes since the January 2009 bankruptcy protection, would be optimistic to say the least. For the past two years I’ve been guesstimating a 15-20% recovery, but it seems I may turn out to be too high.)

Jonathan Chevreau discusses pension reform options in “Will NDP surge tilt pension reform to ‘Big CPP’?” Chevreau is inclined to agree with Jack Mintz in that the “inadequate savings discipline” is the main problem with Canada’s retirement income system. (While inadequate savings rate is a problem, it is just one of the three legs of the collapsing Canadian pension stool. The other two are: (1) the corrosive effects of the high fees associated with Canadians’ investments (e.g. western world’s most expensive mutual funds), and (2) lack of access to a low-cost pure longevity insurance to secure a lifetime income stream and thus protect against running out of money. In addition to the above forward looking pension reform, we must also secure existing commitments to already earned private sector DB pension plan benefits by: strengthening regulatory framework to prevent plan underfunding and modifying BIA/CCAA laws to increase priority of pension plan shortfalls in case of sponsor bankruptcy. Pension Reform: It’s not rocket science; we just have to do it.)

In the Financial Post’s  William Hanley writes former MPs are ““MP pensions insult us all”turfed on to the streets with nothing to show for years of service but measly pensions sometimes amounting to as little as $27,000 a year and only as much as $147,000” at age 55 after only six years of service, and MPs contributing “just one dollar for every four the government puts up”. “That it is so easy to ridicule this perpetual trough pension system starkly shows that it is ridiculous, an insult to taxpayers and no laughing matter. At a time when millions of Canadians are rightfully worried about how they will survive retirement and if their pensions will keep them in old age, the “leadership” of the country blithely maintains a plan that is not only overly generous, but downright unfair.”

Things to Ponder

Jeff Rubin writes in the Globe and Mail, that the answer to “Where will China find the oil to power its economy”is that China will simply stop buying U.S. Treasuries and “Washington’s massive budget deficit will do the rest”. While previously China “felt compelled to become the largest holder of U.S. Treasury bonds to keep its yuan from rising and undermining the competitiveness of Chinese exports…(however in our new world order)… Not only will triple-digit oil prices sever those trans-oceanic trade links through soaring transportation costs, but they will throw the U.S. economy back into recession.” A shrinking economy needs less oil, thus more becoming available to China

In the Financial Times’ “Traditional indices lose trust”Steve Johnson writes that “Three-quarters of European institutional investors view traditional market-capitalisation weighted equity and corporate bond indices as “problematic”… In the fixed income world, investors are concerned about unreliable duration exposure, over-investment in high-risk companies, and liquidity… Nearly half (45.2 per cent) of those surveyed have adopted alternatively weighted equity indices, which includes those that weight stocks using factors such as revenues, earnings and dividend income, as well as equal-weighted portfolios and those designed to minimise volatility. But only 17.6 per cent have branched out into alternatively weighted government bond indices and just 12.5 per cent into similar corporate bond benchmarks. (Whatever problems cap-weighted indexes may have, these are significantly more severe in the bond domain, where companies in financial difficulty have to keep raising additional funds via fixed income offerings.)

Here is some interesting data on the comparative income disparity and trends within different countries in the Economist’s “Rich and poor, growing apart”. “American society ismore unequal than those in most other OECD countries, and growth in inequality there has been relatively large. But with very few exceptions, the rich have done better over the past 30 years, even in highly egalitarian places like Scandinavia.” The article concludes that the root cause is the combination of globalization and technological change. (Recommended by CFA Institute Financial NewsBriefs)

And finally John Carney writes in “Rosenberg goes bullish: Is the end nigh? “If the bull market will end when the last grizzled bear comes out of his den and comes to the table, then hold onto your portfolio, because it may well be dinnertime. David Rosenberg, the curmudgeonly senior strategist and economist at Gluskin Sheff in Toronto, told clients Wednesday in his daily newsletter that he’s finally given up his long-held position that the market is heading for a thud, if not an all-out crash.” (Forecasting is difficult, especially about the future. But given that David Rosenberg has also thrown in the towel after the market has doubled from the lows, this might be considered a worrisome signal, if you believe in signals?!?) (Thanks to Rob Carrick’s Personal Finance Reader for recommending article.)