Hot Off the Web– April 12, 2009

BusinessWeek’s Amy Feldman discusses longevity insurance in “Investment options for the latter retirement years” She quotes Jason Scott of Financial Engines, that the cheapest way to get a guaranteed income is with longevity insurance, a deferred annuity that one may typically buy at 60-65 and starts paying annual income at age 85. He suggests allocating 10-15% of assets to such a product, currently available for example from MetLife and Hartford, and you can live of the remaining funds to age 85 without having to put aside large proportion of your savings in case you live past 85. The usual caveats about “not cheap” and insurance company must be around to payout were included. (Long time readers of this website have read before about longevity insurance, one of the advocacy topics discussed Longevity Insurance and Longevity Insurance- What does it buy you and Longevity Insurance- Delayed Payout Annuities.)

Gillian Tett’s Financial Times article “Gold standard debate roars on“ is well worth reading. It quotes from Alan Greenspan’s 1960s vintage paper that “Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights.” She quotes UBS that given the amount of gold reserves held by the U.S., it would have to be priced at $6,000 an ounce to reintroduce the gold standard. Then she adds that “right now few western governments have any motive to even entertain the debate, given that inflation may soon seem the least bad way to tackle the current overhang of debt. “ She concludes that while she is not ready to bet on the return of the gold standard, she also wouldn’t bet on all the talk about it receding or on gold dropping much below $900. You might also want to read John Dizard‘s Goldbugs rest assured, inflation will return in which he predicts gold price dropping in the short-term due to weak jewellery demand (which represents 70% of current demand), but is long-term bullish on gold because “when inflation comes, it will come in higher than expected, and persist longer than expected, because central banks will not react as they should.”

BusinessWeek’s Roben Farzad in “Jack Bogle’s last crusade?” discusses Bogle’s continuing fight to protect the small investor and “wrest the financial system from overpaid financial middlemen”. He, by the way, is proposing a new type of DC pension plan (clearly almost as broken as the DB pension system). Some of Bogle’s quotes will speak for themselves. “A dollar invested over 50 years at an 8% annual return compounds to $47. But dock two percentage points for expense ratios and transaction costs, and you’re down to $18. Back out another three points for inflation, and you’re at just under $4.” “High fees are especially distasteful to Bogle because, in his view, they pay for such little expertise.” “Once a profession in which business was subservient, the field of money management has largely become a business in which the profession is subservient.”

WSJ’s Damato and Gullapalli “Managed Funds Offer Little Cover From the Bear” remind readers (again, but it is worth doing it again) not to count on active managers for refuge in cases such as the recent market carnage for safe haven. The argument that, unlike index funds which must stay fully invested by mandate to track the index, active managers can move to cash, defensive stock selections and/or derivatives, but results do not support the expectation. But, “stock pickers may add value in periods when the stock market is relatively flat or up modestly.” Clearly, some fund managers have been successful in reducing losses compared to the market, the problem is that you had to pick the successful ones before the fact; on the average active managers were neck-in-neck with the market indexes in bull and bear markets. So the managers must be successful at market timing and you must pick the manager who will be the great market timer before the market timing was required- both very difficult to do, and even when successful the active manager’ performance must overcome the excess management fees associated with an active fund! According to the WSJ flow of funds over the year to end of February supports an accelerating move to index investing with $121B pulled from actively managed funds, and $32B and $122B added to U.S. stock index and ETF funds, respectively.

In the Financial Post’s “Pension fix-up needed” Bader and Gold look at “pension funding and actuarial issues” in the context of public pension plans. They (correctly) attack “actuarial models that mismeasure plan obligations”, underestimate the long-term risk of equities, the (ludicrous and fraudulent) actuarial practice “finds lower liabilities when the associated assets are invested more riskily” (this is, a believe it or not, approach that should have been legislated out of existence years ago.)  (Of course beneficiaries of public pension plans are ultimately protected by government’s ability to tax and debase currency, but do meet the nominal claim of pensioners of the public system. Private DB plan beneficiaries are not guaranteed that protection, so imagine the implication of the authors’ concerns on the private system pensioners, e.g. Nortel)

Kristen McNamara in WSJ’s “Read all about it”has a list of books suggested by experts, which may help you better understand the current financial crisis: Lowenstein’s “When genius failed”, Hayek’s “A tiger by the tail”, Rand’s “Atlas shrugged”, Loeb’s “The battle for investment survival”, Strauss and Howe’s “The fourth turning” and Kindleberger’s “Manias, panics and crashes” (plus many more).

Bret Arendt writes “The case for buying a home right now” in the WSJ. His simple case is based not just on lower (if not bottomed out) real estate prices but also on 5% 30 year mortgages (remember that in the U.S. you still have those) and the possibility (likelihood?) of being able to repay the loan in significantly inflated/devalued dollars.

In the Financial Times’  “Ten principles for a Black-Swan-proof world”, Nicholas Taleb includes the following in his sensible list of his prevention principles: “what is fragile should break early while it is it still small”, “people who were driving a school bus blindfolded (and crashed it) should never be given a new bus”, “don’t let someone making an ‘incentive’ bonus manage a nuclear plant- or your financial risks” and “citizens should not depend on financial assets or fallible ‘expert’ advice for their retirement”. He closes with “Let us move voluntarily into Capitalism 2.0 by helping what needs to be broken break on its own, converting debt into equity, marginalizing the economics and business school establishments, shutting down the “Nobel” in economics, banning leveraged buyouts, putting bankers where they belong, clawing back the bonuses of those who got us here, and teaching people to navigate a world with fewer certainties. Then we will see an economic life closer to our biological environment: smaller companies, richer ecology, no leverage. A world in which entrepreneurs, not bankers, take the risks and companies are born and die every day without making the news. In other words, a place more resistant to black swans.”

In preparation for your 2008 tax return in Financial Post’s “Pension splitting tips for couples” Jamie Golombek reminds readers about the opportunities of pension splitting not just when “your spouse or partner are in lower tax bracket” but even if in the “same tax bracket, but one of you is losing some of your Old Age Security (OAS) benefits due to the dreaded clawback.”

WSJ’s Frederic Marks writes in “Designed to deceive”,  also referring to a recent Craig McCann paper “An economic analysis of equity indexed annuities”, that Equity-Indexed Annuities (EIAs) are/sound too good to be true, “deliberately misleading”, “insurance contracts so complex that it’s virtually impossible for customers or even brokers and agents to evaluate them. Yet salesmen can readily determine that their commission for selling an EIA will be much larger than commissions on mutual funds and even on other annuity products.” (Sounds like somewhat of a scam? but) $25B of these is sold each and every year in the U.S. “An EIA pays the greater of two alternative benefits — a minimum guarantee or a possibly larger benefit based on the increase in value of a stock-market index.” These
are similar to the GMWB products discussed in a couple of blogs last year at this site GMWB I , GMWB II. The message is clear, if you don’t understand them, don’t buy them; and if you really understand them, you probably won’t buy them.

And finally, Bert Hill in Ottawa Citizen’s “Latest Z-mail vague on financials” discusses Nortel CEO Mike Zafirovski’s latest e-mail to employees, but that is not the important part of the article. The critical piece is the mention about the dependence of the Canadian operations on cash from U.S. subsidiary and coming jurisdictional battle over assets located in Canada, U.S. and U.K. “While the details will raise the pulse only of bankruptcy lawyers, the message is clear: with Nortel USA providing the funding that keeps Nortel Canada afloat, creditors want all the sundry Nortel Canadian legal entities locked hard into the deal. That might sound obscure, but the key thing to remember is that bankruptcy will ultimately be a global tug-of-war over Nortel assets. Whatever assets land in a particular jurisdiction will be divided there.”  (Imagine if the Canadian CCAA Court and Federal/Ontario government allow Canadian creditors (pensioners and others) to end up being strangled, with Nortel headquarters and Canadian operations stuck with the bulk of the liabilities, while most assets end up in outside of Canada-not a pretty picture for pensioners.)