Hot Off the Web- September 10, 2009

Personal finance and investing

Surprise? In Globe and Mails “Indexed funds beat managed rivals in the long term” Steve Ladurantaye reports that “Only 16.7 per cent of active funds beat their benchmark over three years, and the number slips to 7.6 per cent over five years. The numbers are much better over a one-year period – with 54.6 per cent beating their index. Over shorter time periods we see active funds adding value, but over longer time periods, active fund outperformance is a rare observance“. “For the first half of the year, only 34.5 per cent of Canadian equity funds that are actively managed outperformed the S&P/TSX composite index.” Also Jeff Brown in NYT’s “Active vs. passive: The debate keeps going” (It does? Not according to the article) reports that “The average investor… does much worse than the investor who buys a block of shares and hangs on through thick and thin”.

In WSJ’s “Why do investors sit tight in 401(k)?”Jason Zweig asks how is it that despite steep losses (>55%) between October and March people still didn’t dump their stocks. What kept these “sitting bulls” sitting still? Some reasons are that: they are doing what they were taught, “contribution effect” (those in accumulation phase keep buying automatically), and inertia. “Investors should be patient, but not catatonic; they should rebalance annually to sell some of what has gone up and buy some of what has gone down.”      (They should also pay attention to asset allocation and location (tax considerations))

In WSJ’s “More investors trying the options play”Jeff Opdyke discusses how some investors “Whether seeking income (selling options to generate premium income, e.g. selling covered calls or selling puts), mitigating risk or just speculating on price movements, investors are trading options in record numbers these days…. Depending what side of the trade you are on, an option involves the right or obligation to buy or sell a stock or index at a certain price on or before a certain date. In the most conservative strategies, the most an investor can lose is the price of a contract, often just a few dollars. At their most speculative, options can leave investors exposed to huge losses.”

WSJ’s Eleanor Laise in “Some funds stop grading on the curve” reminds readers that the normal distribution (bell curve) did not predict the steep market losses last year, and these “meltdowns” aren’t as rare as expected (1987, 1998, 2001, 2008). The other problem is that correlation of asset classes changes dramatically in time of crisis. Ms. Laise discusses some of the approaches proposed to protect the portfolio on the downside. She quotes Mandelbrot (I am in the middle of his very interesting book “The (Mis)Behavior of Markets” on  fractal geometry in finance and) applicability of fat-tailed distributions to finance; some are using these for Monte Carlo simulations.  Others are using hedging against extreme market events at annual cost of 0.5-1.0%. “The fat-tailed assumptions sometimes lead to quite conservative portfolios that cushion investors on the downside but also sharply curtail the upside.” Some are starting to use new (or at least less common) measures of risk such as downside risk, Value-at-Risk. Others suggest that “Since it is so difficult to forecast extreme events, investors should focus on their potential consequences rather than the probability they will occur”. (Sounds like good advice.)

In WSJ’s “Buffering your portfolio against a September slide” Brett Arends explains some of the arguments for “asset allocation funds” (which “can move money between stocks, bonds, cash and sometimes commodities depending on where they see opportunity”) and “market neutral funds” (which “offer some protection against market falls, either by using derivatives or, in a few cases, by shorting stocks “) vs. index funds especially if one doesn’t believe that the trend is up.

In the Globe and Mail’s “Do-it-yourself” escape plan”Rob Carrick describes steps necessary to transfer your account from a full service to an online broker, but he warms “Do not attempt unless you’re ready to manage your own investments.” (Also pay attention to tax impact for items transferred in cash rather than in-kind, if you trigger some capital gains.)


William Hanley’s “Pension Crisis” in the Financial Post is an interview with yours truly on the Canada’s pension crisis in general and Nortel in particular. It includes problems and solution, as well as the basis for next generation pension plans…and if you doubt the powerlessness of the Canadian Courts in protecting Canadian creditors in cross-border bankruptcies read Jacquie McNish’s Globe and Mail article “The perils of cross-border bankruptcies”.

NYT’s Rampell and Saltmarsh in “A reluctance to retire means fewer openings- Lacking a safety net some workers delay retirement”describe “To the long list of reasons American companies aren’t hiring — business losses, tight credit, consumer retrenchment — add the fact that many of their older workers are unable, or afraid, to retire.” The main reason is that unlike elsewhere in the developed world where generous government and corporate pensions exist (not for Canada’s private sector employees) Americans increasingly have to rely on (dwindling) private savings. “Economists say there are advantages to reducing the financial risk for individuals. Pooling investments, in some cases, allows workers to switch jobs more easily and helps lower fees associated with investment decisions, for example.” For average American Social Security covers about 45% of pre-retirement wage (Canadians may be closer to 35% with CPP/QPP and OAS), whereas in Denmark they retire with 91% of salary! In the US (and Canada) a lot of the risk has been shifted to individuals who “are just not capable of making these decisions…Still, the American preference for self-reliance, instead of more socialized financial protections, remains strong, even among those who lost big.”

Real estate: Florida and in general

Tim Padgett of Time in “Florida exodus: Rising taxes drive out residents”reports that “The region — Miami-Dade, Broward and Palm Beach counties — lost 27,400 residents between 2008 and 2009, while Florida as a whole lost 58,000. That’s not exactly a mass exodus for a state of 18 million; but it’s the first net outflow in 63 years for a state that considers itself the new California.” Collapsing property values accompanied by rising property taxes (finally for the resident homesteaders as well; perhaps finally they throw out the corrupt, the profligate and incompetent, and introduce an equitable tax system that will attract people to Florida…don’t hold your breath), rising hurricane insurance costs and still (one of a handful of remaining states with) no income taxes?

The Washington Post’s Dina Elboghdady reports in “Another wave of foreclosures looms” that “About 70 percent of the $189 billion in outstanding option ARMs will reset by 2011”. “Option ARMs, also called pick-a-pay loans, allow borrowers to choose how much to pay each month. Nearly all the borrowers who took out this type of loan from 2004 to 2007 chose to pay less than the interest due.” They bet on rising housing prices would allow them to refinance, but with the mortgages underwater many won’t be able to.  “75 percent of option ARMs financed homes in California, Florida, Nevada and Arizona, where prices have plunged on average 48 percent from the second quarter of 2006 to the first quarter of this year.”

Sun-Sentinel’s “Condo associations turn to receivers to fight deadbeat investors” discusses how condo associations use receivers to fight investors who rent out their units and fail to pay their association fees. They are asking courts to grant them “blanket receiverships” to allow them “to collect rents from tenants living in non-paying investors”.

Bloomberg’s Jeff Plungis in “Wealthy families face bankruptcy on real estate crash” writes that”“Real estate is an incredible thing on the downside,” said Jason Green, a bankruptcy attorney based in Washington. “Equities can only go to zero. Property can go well below zero,” because of expenses such as property taxes, insurance and maintenance on primary residences, vacation homes and investment properties.”

In WSJ’s “The reluctant landlords”M. P. McQueen reports the growing instances of people being forced into becoming landlords after having moved to another city, because they can’t sell their houses or don’t want to sell at current prices. Stats on frequency of occurrence are not readily available but one insurance company reports a 27% increase in homeowners insurance policies being converted to landlord policies. “Experts generally advise against becoming a landlord in hopes of recouping lost home value. In some hard-hit parts of the country, such as Florida, Nevada, Arizona and parts of Ohio, prices may not climb back to mid-2000s levels anytime soon. Landlords have to pony up money each year for property taxes, insurance, maintenance and repairs.” This is especially an issue for those with high mortgage balances.

Things to ponder

Tett and Bullock in Financial Times’ “Markets 12 months after Lehman collapse” report that “”As searing as the experiences of the last year have been, we see capital markets shrugging it off, even as the macro-environment shows some meaningful signs of worsening,” says Robert Arnott”. Stocks are up from lows by 59% and 76% for developed and emerging markets, respectively. Corporate bond prices rose and credit default swap prices show better liquidity. But “What is arguably most significant – and baffling – is that the overall relationship between the price of government bonds and equity markets appears to be defying historical precedent, since both asset classes have recently rallied sharply…some form of correction is likely in either the equity market or the bond market.”

Read about the tug of war between those who see inflation and deflation in Financial Times’ “Inflation-deflation riddle fazes investors” (“There is a complete disconnect between what ordinary persons see and experience (rising unemployment) and the perceptions of investors at this point (rising market)”, Martin Wolf’s Financial Times article “Why it is still too early to start withdrawing stimulus”.

The Globe and Mail’s John Reese writes that “Ask Buffett: If inflation comes, stocks are the best bet”because of equity risk premium, ability to increase prices and thus earning with inflation-while bond’s can’t.

Jonathan Davis’s Financial Times article “Forecasts galore despite unsure times” looks at assorted forecasts. “The issue that has preoccupied investors for most of the year – is deflation or inflation the greater threat? – appears no nearer a resolution.” The recently deceased Peter Bernstein used to say “In their calmer moments, investors recognize their inability to know what the future holds. In moments of extreme panic or enthusiasm, however, they become remarkably bold in their predictions: they act as though uncertainty has vanished and the outcome is beyond doubt.” And French economist Pigou is quoted “The error of optimism dies in the crisis, but in dying it gives birth to an error of pessimism. This new error is born, not an infant, but a giant.” (I guess forecasting is still difficult, especially about the future.)

In WSJ’s “Judge limits credit firm’s 1st-amendment defence” Koppel, Edwards and Bray report that credit-rating firms “had long argued that their ratings were constitutionally protected opinions”, (sounds strange, but true). Well, the judge said no, because “ratings of certain securities — those that were distributed to a limited number of investors — don’t deserve the same free-speech protection as more general ratings of corporate bonds that were widely disseminated.”

And finally, Gillian Tett in the Financial Times’ “A matter of retribution”  asks why unlike in the 90s when thousands of S&L and banking officials were jailed after the S&L scandals, very few have been jailed as a result of a much broader crisis? While timing may be an issue (still quite early), other reasons may be: insufficient legal resources private and public, especially due to “lack of knowledge in Western courts about complex finance”. But while she has little “taste for seeing hordes of bankers heading for jail” and the associated witch-hunt, she believes that without retribution it won’t be possible to achieve behaviour modification, “persuade voters that finance is really being reformed, or has any credibility or moral authority”.


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