Hot Off the Web- December 12, 2011

Personal Finance and Investments

In the Globe and Mail, Shirley Won reports that “Vanguard rolls out first six Canadian traded ETFs”. Vanguard’s Canadian ETFs can be viewed at Note that while all the ETFs are in CAD, some but not all non-Canadian securities based ones are hedged back to CAD; for example VEF (tracking EAFE index) is hedged, whereas VEE(tracking MSCI Emerging Markets index)  is not. Hopefully, Canadians will take advantage of Vanguard’s ‘low-cost’ products, for which it is known. (Though I continue to be puzzled by Canadian investors who persist on buying mutual funds with fees so corrosive to their retirement assets after a lifetime of saving will likely be about half of what they would be, had they invested in low-cost products. I don’t do product endorsements, but low cost is just the tip of the Vanguard advantage: Vanguard having a ’mutual’ corporate structure, meaning that it is owned by those investing in their products, acts as a fiduciary toward its investors, meaning the all actions it takes are first and foremost in the interest of the buyers of their products. I’ve been an investor in their US based products for a couple of decades, and I am also invested in their new Canada based ETF offerings. I hope that they will continue expand their product offerings in Canada including asset allocation, managed payout products, GLWBs and even longevity insurance which are much needed by retiring Canadians.)

In WSJ’s “Price charts can mislead” Simon Constable warns readers about treating with care “price charts”, which (more than likely) do not represent the “total return” of a fund, since they exclude any distributions by the fund. Only total returns are useful in comparing fund performance. The article notes that fund websites report return of funds as “total return”, similarly Morningstar provide charts indicating how the value of an initial $10,000 investment evolves, but Yahoo Finance and Google Finance only have price charts, though you have the option to have “flags showing when dividends were paid”.

Dawn Walton in the Globe and Mail’s “Canadian investors ‘gouged’ by fees”reports that Canada has the highest mutual fund fees among 22 countries surveyed by Morningstar, which led CLC president Ken Georgetti to express serious concerns about the impact on savings. He continues to push for and expanded CPP. The financial industry counters that the net worth of people who get investment advice is almost three times larger than those who don’t. (Unfortunately, while all mutual fund investors in Canada pay for advice, not all actually get (useful) advice.)

In the Vanguard research paper “Asset allocation in a low-yield and volatile environment”Davis, Aliaza-Diaz and Patterson indicate that using the Vanguard Capital Markets Model “Our simulations show that the average annual returns on a 50% equity/50% bond portfolio are expected to center in the 4.5%–6.5% range in nominal terms and in the 3.5%–4.5% range in real terms over the next decade. This central tendency is modestly below the average for a 50%/50% portfolio since 1926 (8.2% nominal, 5.1% real), but it is above that of the past decade in either the United States or Japan, an economy to which the U.S. has been compared recently owing to Japan’s decades-long period of slow growth following a recession.”

In the Globe and Mail’s “Hold on to your long-term strategy, it will pay off” Preet Banerjee refers to Ang and Kjaer’s new paper Investing for the Long Runwhich “confirms the notion that long-term investors have an edge over short-term investors”; long-term for retail investors is defined as “you shouldn’t need to touch the money in your portfolio for at least 10 years”. He suggests that “A prudent long-term portfolio has but a few simple rules: 1) multi-level diversification, 2) rebalance, 3) only take on risk that you can stomach, and 4) keep fees low.” He concludes with Calpers as an example when even professionals screw up the implementation of long-term investing.

In the WSJ article “High income, added risks” Rachel Ensign focuses of some of the risks that come with juicy returns available in some fixed-income closed-end funds. The risks mentioned are: leverage (e.g. Pimco High Income), premium over NAV (e.g. Pimco Global stocksPLUS & Income “81% above its NAV”) and (the ever misleading) return of capital (“Last year, 117 of the 625 closed-end funds on the market—19%—paid return of capital, says Morningstar. Among those that did, an average of almost 60% of their distributions came from return of capital.”)

In InvestmentNews’ “’Enforcement wave’ heading for advisers: Ex-SEC official”Mark Schoeff reports that “An enforcement wave is coming…The world is about to change for investment advisors”. The “SEC’s newfound aggressiveness” is visible in recent charges against advisory firms with inadequate compliance programs and hedge funds’ “improper use of fund assets, fraudulent valuations, and lying about fund returns”. The SEC is following the example of ex-NYC mayor Giuliani’s effective approach to targeting people who have committed small infractions (e.g. jumping subway turnstiles) “to prevent them from growing into dangerous criminals”.

In WSJ’s “How small investors can get stomped” Jason Zweig writes that while small investors can make even small trades at minimal cost, at times some types of trades have unintended consequences or get executed incorrectly, and reporting errors is often required in as little as 15 minutes. Zweig recommendations include: no market orders, only use stop-limit instead of stop-loss orders (a price below which you won’t sell), and complain instantly if there was an error in execution.

Real Estate

Nick Timiraos in WSJ’s “Why home price are (and aren’t) stabilizing”reports that some are finding a silver lining in the September US housing numbers which indicate 1.35% drop in the month and 3.9% from previous year. However, if one splits distressed sales (those by banks with large inventories looking to unload quickly) from non-distressed sales (by traditional owners), “While total home prices were down by 3.9% from one year ago, prices were down by just 0.5% from one year ago when excluding distressed sales… If it’s true that prices of non-distressed homes are stabilizing, even as distressed homes continue to fall in price, it would mean that a distressed home is “increasingly being seen as a poor substitute for a non-distressed home”.


In InHouse’s “Landmark Indalex case goes to Supreme Court” Jennifer Brown reports that insolvency lawyers intervened in favour of the Supreme Court striking down the Superior Court decision in the Indalex case. The argument according to the insolvency legal community is that if the case stands other companies in reorganization will be unable to obtain DIP funding to execute the reorganization if pension plan gets priority over DIP funding. (DIP funding typically occurs after company is in reorganization, so obviously a lender would not lend if it looked like it wasn’t going to be repaid, but this is just obfuscation of the real situation that exist in most cases. The real issue is, whether pension plan has priority over other creditors already in place pre-reorganization. Hopefully the Supreme Court will make that distinction clear, and rule that pension plan has priority due to it being “deemed trust” and that the sponsor’s fiduciary duty to pension plan beneficiaries trumps its fiduciary duty to shareholder, to resolve this ludicrous conflict of interest once and for all. Hopefully the Supreme Court will also take the opportunity to recommend that government make explicit changes to the BIA/CCAA legislation to fix this injustice that is currently permitted by the law. Thanks to VK for bringing article to my attention.) See also in Bert Hill’s “Venture financing bounces off bottom”where he writes that “Nortel had billions of dollars in cash on hand when it went into bankruptcy protection. It didn’t need outside financing; it needed a board with patience and courage. Now Nortel pensioners and other creditors are at the mercy of a complicated global bankruptcy in which U.S. creditors, particularly bondholders, might get more than 100 per cent of their claims (based on recent Nortel bond trading) Canadian creditors could receive much less.”

In Benefit Canada’s “Will PRPPs close the pension gap?”Robin Pond concludes that (given what PRPP appears t be) “rather than introducing all the additional regulatory complexity of PRPPs, perhaps a simpler approach would be to try to improve RRSPs, attacking some features such as the cost structures that remain too high, while still allowing Canadians to retain control over their own money. In this way, retirement benefits would continue to appear to be benefits, rather than disguised taxes.”

In the Financial Times’ “Insurance venture to take on pension liabilities” Paul Davies reports on a new insurance company venture which offers “companies a lower cost way to offload their pension liabilities than other insurers, but only if those companies also take an equity stake in the new venture…”.  The pension industry is called “a toxic industry that needs to be decommissioned”. They argue that while final salary based DB pensions are important to those who have them, they are of no interest to companies or most of their employees (who are no longer eligible to participate). Article indicates that equity participation by the companies off-loading their pension plans allows them to “retain the profit that normally would be handed over to the insurer”. (Interesting/innovative approach, but only time will tell whether it will be effective in first getting the pension business and then delivering the promised pensions.) In a related story, “Sun Life announces an industry first in Canada with the introduction of longevity insurance“does not refer to the common definition of ‘longevity insurance’ (i.e. a delayed payout annuity), but rather an insurance to be purchased by the sponsor of DB plan to offload the risk increased pension costs resulting from increasing population longevity. (This type of insurance has been on offer in the UK for a number of years with very little uptake, likely because of high cost; insurance companies have some capacity to write such insurance when they have a large book of life insurance which would act as a hedge against an unanticipated longevity increase.)

In the Financial Post’s “Monica Townson: Finance Ministers bungled pension reform when they chose PRPPs over Big CPP” Jonathan Chevreau reports that “Canada’s finance ministers bungled pension reform when they chose the new Pooled Registered Pension Plans over expanding the CPP, says veteran pension observer and social policy consultant Monica Townson in a report for the Canadian Centre for Policy Alternatives.” (Much of what is wrong with the PRPP is enumerated. This is not news, but it’s becoming a growing chorus condemning the PRPP; it seems like, so far, the Canada’s financial services industry is the only one enthusiastic about the PRPP.  This is probably related to my pessimistic observation some months ago that “The PRPP (Pooled Retirement Pension Plan): An agreement to do no pension reform but deliver more fees to Canada’s financial industry”.)

Things to Ponder

In Advisor Perspectives’ “Are TIPS really safe and worry free?” Wade Pfau a challenges the assertion that TIPS can be the cornerstone of a safe retirement plan. Pfau tables a list of arguments to support his thesis including: default risk of TIPS is greater than nominal government bonds (the  inevitable inflation resulting from government’s continued printing of money and ability to manipulate inflation measure used to adjust TIPS obligations is similar risk to foreign currency obligations), fluctuating yields lead to reinvestment risk of the lifecycle of an individual thus creating uncertainty in required savings for retirement, “low (and even negative) yields make retirement planning costly”, lack of track record for TIPS in retirement  portfolios (e.g. future availability) increases uncertainty in their use.

A related story is Bloomberg’s “Hedging your life expenses (Isn’t so easy)” in which Lewis Braham writes “TIPS are an imperfect solution as a personal inflation hedge because the CPI tracks a broad basket of goods, many of which you may not consume, or not in the same quantities as the average American does. The consumption patterns of retirees differ dramatically from those of the rest of society — especially, for instance, in the area of health care. What’s more, TIPS are sensitive to interest rates, just like regular bonds. Right now, because conventional Treasury bond yields are so low, TIPS yields are, too. In fact, newly issued TIPS with maturities of less than 10 years offer negative “real” yields, which is a bond’s yield adjusted for inflation. Earning less than the CPI doesn’t afford much protection.” Braham then proceeds in search of alternative inflation hedges and concludes that “Each product that offers some protection has imperfections — and critics.” Examples of imperfect hedges are: futures for food prices (a broad commodity futures is more appropriate than individual commodities), health care costs rise faster than CPI and make up a higher proportion of expenses for seniors than society in general are a higher risk (invest in a healthcare ETF an amount consistent with the cost healthcare expenses in retirement, $250,000 for a retired US couple). And of course hedges don’t necessarily work out as expected.

In the Economist’s “Negative reaction”Buttonwood writes that “To an extent, the euro zone is damned if it does, and damned if it doesn’t. Failing to have a plan to reduce its debts will result in a downgrade but austerity plans will hit economic growth that will also result in a downgrade. While this seems unfair, it is all part of the “wouldn’t start from here” problem that faces the region. This blog has consistently argued that we have created too many claims on wealth in the form of debt that cannot be satisfied. These debts will thus be defaulted on, or inflated away; choose your poison.”

In the Financial Times’ “Multi-asset funds offer clients a one-stop shop”Sophia Grene reports that a number of managers are launching emerging market asset allocation funds so you don’t have to make the separate emerging market debt/equity allocation decision. This extends recent trend of pension funds outsourcing overall asset allocation decisions. Though, Grene argues that this is different in that it “treats emerging markets as a coherent investment asset class.” The benchmark for one of these EM asset allocation funds (instructively) is 50% stocks, and 25% hard currency and 25% local currency debt. Such EM asset allocation funds also offer the promise of reduced volatility as compared to pure EM equity funds.

And finally, reading Forbes’ “A review of Emanuel Derman’s new book: Models.Behaving.Badly”  suggests that Derman’s new book might be worth reading, especially by those who put blind faith in financial market models. He (like a few others before him) make a distinction between modeling physical phenomena (governed by physics) as opposed to financial markets which are significantly impacted by (unpredictable) human behaviour (e.g. he notes that “Financial modeling is not the physics of the markets”). Derman’s conclusion is that ““after twenty years on Wall Street, I’m a disbeliever…In physics you’re playing against God and he doesn’t change His laws very often. In finance you’re playing against God’s creatures…” In Emanuel Derman’s experience, God’s creatures have been gloriously, but consistently, messy and unpredictable.” (Thanks to Ken Kivenko of Canadian Fund Watchfor recommending.)


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