Hot Off the Web- September 12, 2011

Personal Finance and Investments

Preet Banerjee in WSJ’s “Capitalistic greed the downfall of fund performance”suggests that managers do have skill and “It’s clearly possible to beat the market, it’s just very hard to predict who will do it in the future. More than one study indicates that outperformance by a fund manager might be due to nothing more than skill…. most managers have skill to at least earn back their fees. Unfortunately, when investors identify outperformance they give these managers more and more money, up to a point that they can no longer deploy it effectively.” (Even in the case of the “more than one” study subjecting skill vs. Luck as the reason for outperformance, the investor is wasting his time; the investor must find the manager who will demonstrate skill in the future, sufficient to beat costs, but then more money pours into the manager and he no longer is able to outperform. Oh well, back to indexing and asset allocation)

In the Journal of Financial Planning’s  interview “Roger Ibbotson on hedge funds, liquidity, and the myth of capricious markets”Ibbotson indicated that: data shows hedge funds not only have positive alpha’s since 1999 including through the financial crisis (i.e. for a given level of risk they returned about 3% excess over the market) but still had negative return during the crisis due a beta of 0.4 and therefore are only partially hedged, they require more complex due diligence and thus are unsuitable for individual investor, believes that stocks will outperform bonds over reasonably long periods particularly now that interest rates are so low that they can’t fall (much) so you are getting not only low income but if interest rates rise you’ll also get capital losses, individual investors underperform the market not just because of high costs but also due to very poor timing, can’t count on converting high Chinese growth into corresponding returns due to poor corporate governance, must factor human capital into financial planning so young working individuals should generally be very heavily invested in stock, human capital also affects the need for life insurance and protection against longevity risk, and he believes that there are investment opportunities looking at “liquidity premiums”.

In the Globe and Mail’s “Are you looking for a nanny?” Shelley White looks at the high cost of daycare and suggests also exploring the use of a nanny; this might also be applicable for seniors who may not be able to stay in their homes independently. She also gives links to website for additional information (Thanks to Rob Carrick’s Personal Finance Reader)

In the NYT’s “For the recently widowed, some financial pitfalls to avoid” Ron Lieber tackles financial matters for grieving widows. “The pitfalls for widows are well-enough known that there are books for them, including “New Widow Financial Lifeline” and “Moving Forward on Your Own.”… (also the) Web site of Timberchase Financial called “What Do I Do Now?”” Lieber discusses the urgent matters (paying bills and taxes), understanding health insurance (US in particular), and collecting life insurance policy, make “no irreversible decisions soon after the death of a spouse”,” watch for bad actors who prey on recently widowed” (annuity pitches will be common), home related decisions (paying off mortgage from life insurance while you may need the money later, or deciding to sell the house immediately), how to respond to request of children who want an inheritance advance (generally answer should be no until you ascertain that you can’t run out of money), “not-always-gentlemen callers”, and watch out for concentrated positions that you spouse might have left you with instructions never to sell.

Rachel Emma Silverman in WSJ’s “Wills: How to give one child less”discusses how differences in family members (e.g. needs, primary caregiver, etc) might also drive differences in property allocation in an estate, mechanisms to insure that desired distribution sticks even if challenged by some relatives and preparatory work to prevent surprises, all the way to a detailed explanation in the will of the reasons why a specific allocation was chosen. She also has a book on the subject.

In a Macleans interview “In conversation: David Chilton”, author of The Wealthy Barber, explains why he wrote a new book (The Wealthy Barber Returns). “I’m telling people to manage their expectations and get more realistic ones. There’s a line in the book, which, at the time, didn’t seem all that important, but is really an important part of what I’m trying to say. And that’s that we’re not bad savers, it’s that we’re fantastic spenders. And until we get the spending under control, the saving will never take place. Most people agree that this drive toward consumption and possessing as much as we possibly can is not translating into better happiness levels. In fact, it may be doing the opposite by creating tremendous stress about people’s futures, financially.” (I haven’t read his book, but it is actually a key message. You might also consider reading my Control what you canblog)

In the Globe and Mail’s “How to reduce tax hit on an inheritance” Tim Cestnick explains the problems associated in the case when the value of the assets, with a lot of unrealized capital gains, in an estate drops shortly after the death of the grantor; the solution might be: “Subsection 164(6) of our tax law will allow any capital losses realized in the first taxation year of the estate to be carried back and applied against any capital gains that might have been reported on the deceased’s final tax return.”

In Bloomberg’s “New regulators for investment advisers proposed in US House”Jesse Hamilton reports that a bill is coming before the US House Financial Services Subcommittee proposing that the industry’s self-regulatory organizations (e.g. FINRA) be put in charge of overseeing Registered Investment Advisors. The argument being that the SEC has been totally ineffective (e.g. Madoff) and due to government funding restrictions would continue to be resource restricted. (The SEC’s interim recommendations on the subject did include the SROs as one of the overseer options, but if this ends up to be the new implementation it would be a major step backward in investor protection, since RIAs are currently overseen by the SEC. What’s needed instead is that brokers, insurance agent be also be overseen by independent rather than self-regulatory agencies.)

David Spiegelhalter’s “Understanding uncertainty: How long will you live” has some fascinating graphs on longevity. The most interesting to me was the last one in this article which gives you a sense of the extent to which lifestyle choices (smoking, alcohol, exercise and healthy eating) determine survival. (Thanks to Ted Rechtshaffen who referred to it this week in his Globe and Mail article “You may live longer than you think” )

Real Estate

Karen Blumenthal in WSJ’sSix mistakes housing investors make”explores whether “bargain” level house prices and growing demand for rentals, might be an opportunity for a house as an investment which she says is uncorrelated to the market. “Before you start scouring for deals, keep in mind that owning rental properties is time-consuming, expensive and fraught with challenges, and many investors lose money. You will want to avoid falling into one of these common traps.” She then enumerates some common mistakes: “Confusing a cheap deal for a good deal” (location, demand, desirability), “overlooking key costs” (closing, fix-up, maintenance, holding costs, repairs/assessments property management costs if you can’t do it yourself), “assuming you’ll sit back and watch the rent roll in” (“when you become a landlord, you become a rent collector” and if necessary a tenant evictor which might take months requiring the assistance of courts), etc.


In the Financial Times’ “Gap in US pension plans hits $388 bn” Dave McCrum reports that “A $388bn gap has opened due to a combination of weak equity markets and falling interest rates, eliminating improvements in the funding of defined-benefit pension plans at S&P 500 companies since the end of 2008. The gap leaves pension schemes with assets worth only 77 per cent of their liabilities.” “If you think about the typical corporate pension plan, they are continuing to take two big bets: they are betting on interest rates and they are betting on the equity market – and they hope that both go up.” “Unless companies close defined-benefit schemes to new employees, new obligations continue to accrue, while existing obligations are not static but grow over time, requiring normal investment returns just to keep pace.” (When Canadian companies make these bets and they still end up in bankruptcy protection, they essentially make them with pension plan beneficiaries’ assets; the upside belongs to the company shareholders, while the downside of these bets flows directly to retirees, since the is no safety net for failed private sector pension plans in Canada (except a minimal one in Ontario)…shame…)

In a Bloomberg editorial “Social Security is no Ponzi scheme” the editors describe a detailed plan to fix the problem. They argue that “there is nothing wrong with the program that Congress couldn’t fix in a week. Gradually raising the retirement age to 69, changing the formula for cost-of-living increases, and raising the cap on wages subject to the payroll tax would close most of Social Security’s funding gap for the next 75 years. Such changes would rely about 60 percent on tax increases and 40 percent on benefit cuts, and would mainly affect the wealthiest Americans by asking them to pay more and get less in return. In the end, Social Security would be more progressive and benefits for the very oldest and the very poorest retirees would be enhanced.”

Last week in my LIF- What is it, and why important for Nortel pensioners blog, I discussed LIFs which are the final resting place of many Canadian locked-in pension plans’ commuted values. These are very similar to RRIFs, in that they also have age related minimum withdrawal requirements, however LIF also have age related caps on maximum annual withdrawal requirement to protect as much as possible an income stream for life. My blog tended to focus on general principles and Ontario specifics. A reader contacted me to ask about options in Quebec. According to a posting at the NRPC website, Quebecers have an extra option (not available to Ontarians). Unlike in Ontario where upon windup you have to choose between an (1) annuity or a (2) LIF, in Quebec you also have an option (3) “Administration of the remainder of the pension by the RRQ for up to ten years while guaranteeing an amount no less than the annuity option”. So while, there are the three options, it is not clear whether the LIF option is available after the initial choice is made, meaning that once one has chosen to have one’s commuted value be managed by the RRQ (or taken the annuity path) there appears to be no option to transfer to a LIF (no doubt this will be explicitly specified at windup one way or the other). If this will turn out to be the case, once additional information is available, then there appear to be two forks in the road: (1) upon windup: decide to take or not to take the LIF (i.e. decide whether you’ll ultimately annuitize or not; this decision would be based on some personal factors like: age, health, other assets that you can fall back on, your risk tolerance, desire to leave an estate) and (2) at the same time, if annuity path is favoured, then it appears that initially it might be preferable to choose the RRQ administration (rather than immediate annuity) route, since the RRQ guarantees the floor value of the annuity; so that pensioner has only upside from level of the annuity available at windup. So on the surface one might say that on day one you’ll have only two options, to choose between a LIF and initial RRQ management of the fund; so it’s a good idea to start thinking about this now.

In the Ottawa Citizen’s “Breaking up is hard to do” James Bagnall summarizes some of the Nortel history since it sought bankruptcy protection in 2009. The article does an excellent job on shinning light on the crippling legal costs associated with such a complex multijurisdictional bankruptcy. (The immense and unquantifiable human cost is not covered, though no doubt somebody will write the story some day.)

Things to Ponder

In an excellent WSJ article “The age of ‘macro’ investing” Jason Zweig puts in perspective the impact of the past ten years that investors have gone through. Since 9/11 “investment portfolios have seemed to be at the mercy of what professional investors call “macro” forces: natural disasters, geopolitical shocks and sudden, systemic failures of stock markets and national economies, from Hurricane Katrina and the financial crisis to the Japanese earthquake and, now, the unraveling of Europe.” He discusses the differences between risks that come from within and outside the market. The difference between risk and uncertainty (you might also be interested in reading my “Risk perspectives: What is risk? Its measurement, dimensions, modeling (asset classes, risk factors and regimes)” blog) and that “for someone trying to manage an investment portfolio for retirement or other goals, the unsettling reality is that you can’t inoculate your holdings from macro events. But by understanding the difference between risk and uncertainty and putting the proper strategies in place, you can control how you respond.” The 80s and 90s made people arrogant expecting indefinite 15-20% returns indefinitely. After the past 10 years of miserable returns coupled with the media’s and social networking’s “unfiltered spread of news”, “we all get a wide variety of instantaneous images that are likely to have more-inflammatory effects.” But this not new; it is similar to the 50s when Benjamin Graham wrote that “The possibility of a third world war weighs heavily on all our minds.…The effect of such a war upon ourselves and our institutions is incalculable.” Zweig continues that “In a world where fear warps perceptions of risk, it may be a long time before owning stocks is no longer a painful ordeal. If you have a low tolerance for that discomfort or you are in or near retirement, then you should almost certainly reduce the proportion of your assets you have dedicated to stocks.” But “Nor are stocks substantially more volatile than they have been in the past; they only seem that way… Today, however, every fibrillation is recorded in real-time pulses, making it unbearable for many investors to watch their account values fluctuate—and thereby shortening their horizons. But you will never be able to outperform professional traders who have high-speed computers and special access to market data. Instead of trying to shorten your horizon to compete with them, lengthen it. Bear markets may be gut-wrenching, but they are the only means by which future returns can be raised.” (Well put!)

In the Financial Times’ “Before whacking speculators for commodity swings” Gillian Tett reports on the coming curbs on commodity markets. Still the tug of war between those who argue that fundamentals (supply/demand imbalance) are the cause, while others blame the “financialization” of commodities is responsible for high prices. Tett says that another way to look at commodities is in terms of production costs. In the past, speculation was blamed for price increases when”quantity of production, consumption and inventory” didn’t explain the prices. She thinks there is a credible story that 5-year futures are being affected by increasing marginal production costs (e.g. cost of finding new oil reserves in more “remote and dangerous regions”). While some are challenging traditional thinking or even the new perspectives, and want to focus on the speculation angle, she cautions that it would be a mistake not to look at the picture holistically.

Deborah Ball in the WSJ’s “Euro woes stir currency fears” writes that “In a new sign of how turmoil in financial markets is convulsing economic policy around the world, Switzerland’s central bank said it “would seek to repel the floods of capital pouring into the country by capping the surging Swiss franc…. the Swiss National Bank said it would buy euros in “unlimited quantities” whenever the single currency fell below 1.20 francs, setting the stage for what could be a long battle with the financial markets… Economists worry about the specter of a so-called currency war, in which a growing band of countries seek to lower the values of their currencies to protect their economies.” (I think we have seen that before.)

In WSJ’s “Debt hobbles older Americans”E. S. Browning writes that “more Americans reaching their 60s with so much debt they can’t retire”. In the 60-64 year range the number of household heads with mortgages has increased from 20% in 1994 to 39% in 2010. The housing crash prevents those who still have mortgages at that age from selling to eliminate their debt, as was the case historically. The outstanding mortgage debt for that age group has also increase from $40,000 in 1994 to $80,000 in 2008, forcing many to continue working into their 70s. “The combination of easy credit, low interest rates and a consumption-oriented culture helped fuel a spending binge for Americans until the financial crisis. People with problems aren’t just those who took subprime loans or spent foolishly on lavish lifestyles. They are people from all backgrounds, including some with six-figure incomes.”

Pauline Skypala in the Financial Times’ “Securities lending: kept from view”writes that ” Fund managers (including those of ETFs) stand accused of failing to disclose vital information about the risks they are taking with investors’ money by lending out the securities they hold in the funds they run, and of not sharing fairly the fees they receive for this lending activity… in the Financial Services Authority’s handbook, and says there are few restrictions. Managers can enter stock lending agreements provided they believe they can generate additional income for the fund “with an acceptable degree of risk”, the handbook says. Mr. Miller maintains this means the fund could get 1 per cent of the income while the managers get the rest, even though the investors in the fund bear 100 per cent of the risk… The main risk with stock lending is that if the borrower goes bust and cannot return the shares, the cash raised from selling whatever is held as security will not be enough.”

In the WSJ’s “How to spot signs of a rebound”Ben Levisohn gives five indicators to watch for a rebound: “junk-bond” spreads (correlation of -0.9 with stocks), option prices (the difference between puts at market and at 10% less than market), correlation of S&P 500 and stocks in the underlying index (“stocks moving in sync”), euro “basis swaps” (measuring risk of default) and fund flows (driven by investor sentiment).

Last weekend I read with some sadness that William Hanley indicated his retirement in the Financial Post’s “My final column, and a fond farewell”. I always looked forward to what he called in his article his cynical and sceptical view of the markets; but no doubt that many, like me, saw those views as realistic. The mixture of relief and regret he mentions, resonates with the feeling I had upon retiring after 30 years at Bell Northern Research/Nortel. But throwing off the harness to have the freedom to only worry about self-imposed deadlines and projects can be truly liberating. I wish Bill many happy and healthy years, with many exciting self-imposed deadlines. I’ll be forever grateful to Bill for helping me shine much needed light on two of my advocacy topics in, the discriminatory Florida property taxes and the systemic failure of Canada’s pension system.

And finally, it is well worth watching WSJ’s 20 minute video “Why Mark Cuban is wrong on investing” in which Jason Zweig interviews John Bogle. Bogle discusses very clearly topics such as: diversification and asset allocation, buy-and-hold, gambling vs. Investing, index funds and their market impact, systemic risk with ETFs (40% of trading, leverage, inverse, synthetic), ETF speculation, international investing, apocalyptic events against which you can’t hedge, gold (he doesn’t own it) and his ongoing mission to educate Americans about investing. “As for the double-digit annual gains of the 1980s and 1990s, Mr. Bogle said, “the idea that that could recur again is something to do with insanity.” But Mr. Bogle noted that the returns of the past three decades, averaged together, come close to stocks’ long-term average annual gains of nearly 10%.Over the next decade, Mr. Bogle said stocks are likely to generate an average annual return, including dividends, of around 7%. “Your money will double in 10 years,” he said. “How bad is that? People ought to get over the illusion [of higher expectations] and realize that they may have to invest for longer time periods, start earlier and save more.””


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