Hot Off the Web– June 13, 2011

Personal Finance and Investments

In Bloomberg’s “Investors prefer commissions to account fees, Cerulli study says”Elizabeth Ody reports the results of the latest study which indicates that: 47% prefer commissions, 27% asset based fees, 18% prefer retainer fees and 8% hourly fees. As to cost of advice: 33% didn’t know how they paid for it, 31% thought it was free (triumph of hope over reality); 64% thought advisor is “held to fiduciary standard of care” actually brokers held to much weaker ‘suitability’ standard’). (Furthermore, I didn’t see any mention of a question on whether client understands what constitutes advice; sometimes one wonders if questions are structured to get the answers you are looking for and obfuscate rather than illuminate and educate.)

Speaking of what constitutes ‘advice’, see this week’s Globe and Mail article “Think of your investment policy statement as a financial destination” in which Preet Banerjee writes that investing without and IPS is like a “flight without a destination”. He adds that “An IPS should be detailed enough that if your adviser were to retire or pass away, your new adviser could pick up right where they left off. It also has to be simple enough that it makes sense to you.” (So if you think you are getting ‘advice’, but you don’t have an IPS, then it’s time to ask some questions.)

The arrival of Vanguard to Canada is great news for Canadian investors (and a significant threat to Canada’s mutual fund companies running the developed world’s highest fee mutual funds). Benefits were identified in many articles on the subject. In Bloomberg’s “Vanguard opens Canadian unit to help drive fund sale expansion abroad” reports that Fund-research company Morningstar Inc. has referred to the “Vanguard effect” to describe how the firm’s 2009 entry into the U.K. funds market caused other competitors to lower their fees. In the Financial Post’s “Vanguard officially confirms launch of Canadian business” Jonathan Chevreau quotes Vanguard CEO as saying that “Although Canada has a very well-developed asset management market, we believe our unique value proposition of low-costs, client alignment, and enduring investment solutions will resonate with Canadian investors.” In the WSJ’s “Getting personal Canada: Vanguard’s entry changes landscape” Monica Gutschi identifies other benefits to Canadian investors like “That could mean that Vanguard is planning to offer its ETFs to affluent retail investors who work with advisers, suggests Dan Hallett, director of asset management for Highview Financial Group. This group is likely to be wary of Vanguard’s U.S.-domiciled ETFs due to potential estate-tax implications and the impact of currency fluctuations. The Canadian versions would avoid these issues…Canadian investors are “more in tune on what costs do to long-term net returns” because of the global comparisons, Tiwari (Vanguard’s new Canadian head) said. Furthermore, Tiwari said regulatory changes mean there will be a growing number of fee-based advisers in Canada, a channel that he believes is “complementary” to Vanguard’s low-cost products and services. He said about 20% to 30% of advisers have moved to a fee-based model from a commission system, equivalent to the U.S. about a decade ago. About 60% to 65% of U.S. advisers have now changed to a fee-based model and Vanguard believes Canada will move in the same direction. See Vanguard’s Canadian website, which by the way indicates….that its “initial focus in Canada will be to offer investment products to Canadian investors through investment advisors”. (This is strange and intriguing; strange because in Canada has no standards/requirements for what an ‘advisor’ is or should be, and intriguing because depending of what business model they might be contemplating, given their ‘mutual’ corporate structure with the implied working exclusively in the interest of the customer, this could influence the evolution of the Canadian ‘advice’ market as well as lead to some unique retirement product innovation. Arrival of Vanguard will not only increase competition in Canadian index based ETF space, but possibly also in the actively managed mutual fund space in which Vanguard also is a player in the U.S. Hopefully they’ll also bring much needed product innovation benefiting Canadian investors in general and retirees in particular.)

In WSJ’s “Don’t play dead with your rollover”Karen Blumenthal reports that as people leave their jobs or are ready to retire, they are being approached by brokers/advisors to roll over into an RIA. She writes “Don’t play dead with your rollover” and suggests that you look before you leap into moving your account from your previous employer, because: he who approached you does not (necessarily) have your best interest at heart, you’ll likely end up paying higher fees, if account <$50,000 you’ll be treated a second class citizen, and you might have less protection from creditors with a 401(k).

In the Financial Post’s “After the financial crisis: 5 big risks baby boomers face in retirement”Jonathan Chevreau quotes Fidelity Canada’s Peter Drake’s key risks faced by boomers in retirement: longevity risk, inflation risk, asset allocation risk, withdrawal rate risk and health care risk. (Not much news here, but some comments on two of the risks mentioned: asset allocation and withdrawal rate. There could be risks associated with these, like being too conservative on the former and too aggressive on the latter, however these are rally are not risks but some of the few controllables in your retirement finance plan and execution.)

Richard Thaler writes in the NYT’s “The annuity puzzle”about the challenges of decumulation by the situation of two 65 year old identical twins, one retiring with a traditional pension of $4,000/mo for life and the other choosing a lump sum to be self-managed. If the latter chooses a conservative bond portfolio then drawing $4,000/month will result running out of money around age 85, alternately he could draw $3,000 a month and have a lower standard of living. He discusses reasons why people who could annuitize the lump sum, yet choose not to do so. He concludes with “Whether the cause is a possibly rational fear of the viability of insurance companies, or misconceptions about whether annuities increase rather than decrease risk, the market hasn’t figured out how to sell these products successfully. Might there be a role for government? Tune in next time for some thoughts on that question.” (While I don’t agree with Thaler that annuitization is a no-brainer decision (and not just because of insurance company viability risk and desire to leave an estate, but also due to the corrosive effect of  inflation, an almost 50% purchasing power erosion results with annual 2.5% inflation over a 25 year long retirement. Still, despite misgivings about demonstrated government effectiveness, longevity insurance may in fact be a natural for government (or a non-profit) implementation…and I am referring to pure longevity insurance, not immediate annuities. We’ll have to stay tuned for what Thaler suggests in his next article on the subject.)

In a 2011 CFA Institute Conference paper “Evaluating retirement income strategies in an outcome-based framework”Chad Runchey writes that “Rather than a single objective of trying to grow wealth to a targeted amount, a retirement income strategy must address multiple objectives, including income security, spending power protection, wealth and estate transfer, and liquidity funds to cover rainy day expenses… It’s not just effect of inflation, unknown age of death and health care cost but “risks are amplified in retirement for two reasons. First, retirees have a diminishing asset base. If assets are not being withdrawn, inflation erodes real return. If assets are withdrawn, the asset base begins to diminish quickly. Second, the time horizon shifts… little time to recover if an unexpected event occurs.” Runchey’s analysis confirms that both for the 0% and 100% wealth transfer objective, income is maximized by a pure longevity insurance product, as part of the strategy. (While the value of insurance products in general is undeniable, I am less convinced about his endorsement of the value of high cost and high load factor GLWBs, LTCI, immediate annuities and universal life insurance products, except as a general principle to be considered for their applicability to specific individual cases, and compared to other available options. Much of the value brought by insurance products to financial security has been eroded when insurance companies converted from a mutual- policyholder owned- corporate structure, to a public shareholder owned structure; suddenly what was a fiduciary responsibility owed exclusively to policyholders became one where fiduciary duty was now transferred to public shareholders.)

Kelleher and Skypala in the Financial Times’ “Vanguard defends ‘buy and hold’”quotes Vanguard’s chief investment officer Sauter that “If you believe buy and hold is dead today then it was dead always,” said Mr Sauter. “We’ve never observed any market timers or people roaming the markets that can add any value or outperform.” “Mr Sauter also said buy and hold investors were not losing out to shorter term investors such as high frequency traders any more than in the past. “There have always been people on the other side of the trade,” he said.” (By the way, ’buy and hold’ is not literally buy and hold, since the requisite rebalancing forces you to sell high and buy low over time.)

Real Estate

Steve Ladurantaye reports in the Globe and Mail’s “Vancouver primed for housing correction: BMO” that “Vancouver’s housing market looks primed for a correction, according to a report from BMO Nesbitt Burns, with the average house now costing “an astounding” 11.2 times a family’s average income — more than double the national average. But senior economist Sal Guatieri said there’s hope that any drop in prices could be less severe than previous corrections — “if interest rates stay low and wealthy immigrants continue to pour into the city, prices could stabilize sooner than in past downturns.”” “Greater Toronto house prices have nearly doubled in the past decade, and now stand at a high 6.7-times family income, compared with 4.3-times in 2001. This is comparable to valuations in the late 1980s that were subsequently followed by a 25 per cent slide in prices….”

And speaking of popping real estate bubbles, in WSJ’s “The great property bubble of China may be popping” Bob Davis reports that “Residential prices are heading downward in some major cities, damping some undesired real-estate speculation but raising the prospect that the Chinese economy may slow more rapidly than anticipated with profound consequences for global growth…in the opening months of 2006 an average-price new apartment in China’s capital would cost around $100,000—the equivalent of 32 years’ disposable income for the average resident. By 2011, the average price had more than doubled to $250,000, but relatively modest increases in income mean it would now take 57 years of saving for the average resident to cover the cost…sales volume in the nine cities it tracks fell by about half since the start of the year. In Beijing, that has meant rising rents.”

In WSJ’s “Why it’s time to buy?”Simon and Silver-Greenberg report that given the massive losses suffered by residential real estate and (30 year) mortgage rates as low as 4.5-5% “the ratio of home prices to income is now 20.9% lower than the 15-year average through 2010, and 12.5% lower than the 1989-2004 average. A historic glut of homes, meanwhile, has created a buyer’s market: There were about 15 million vacant homes in the U.S. last year.” Given little or no new home building and an expected increase of “household formation” after a number of lower than usual years, due to unfavourable economic situation, could lead to a soaking up of existing inventory. So a combination of demographics, affordability hopefully improved employment prospects, better credit availability and (home ownership) psychology could reverse current situation. (We are just not sure of the timing of such developments.)

Kim Miller in Palm Beach Post’s “Nearly 50% of Palm Beach County mortgages underwater or nearly there” reports that “43 percent of Palm Beach County mortgages are underwater while another 4 percent are nearing negative equity.” (Overall the state of Florida is at about the same level as PBC, while Arizona and Nevada are in even worse shape, see the very revealing table of Negative equity by state .)


Jonathan Chevreau reports in the Financial Post that “Don’t double down on big CPP, CD Howe warns”. He is referring to William Robson’s CD Howe report entitled “Don’t double down on the CPP: Expansion advocates understate the plan’s risks” in which he writes that”pension-plan participants should understand that they have a choice. They can invest in assets that do not match plan liabilities in the knowledge that their benefits are aspirations – targets that may be missed. Or they can invest in assets that do match plan liabilities, and pay the resulting higher price for the guarantee…projections using RRB yields – which private-sector pension plans must use for indexed pension liabilities – would indicate that it (CPP) already requires a contribution rate well above 11 percent to avoid benefit cuts…A cogent objection to using the RRB yield to evaluate the CPP would be that the CPP is not, in fact, a defined-benefit plan. To repeat, the 1998 reforms not only built in provisions for automatic benefit cuts if needed, but also trimmed benefits at the time. So the CPP is a target-benefit plan that, in principle, might justifiably not match its assets and its liabilities.” (As I have indicated before, the CPP is not a DB plan but a target date plan, furthermore given it’s scale, it is not a cheap one (see “Is the CPP low cost?”) . However, building incrementally on its administrative infrastructure, it could be quite inexpensive, especially compared to the PRPP which just delivers unsuspecting Canadians into the arms of the Canada’s high fee financial services industry. Bottom line: I agree that CPP is no DB plan, but is a lot better than the proposed PRPP. No doubt there are even better solutions than an expanded CPP (e.g. as described in Pension Reform: It’s not rocket science)

In the Globe and Mail’s “Pension tension and the battle over Indalex” Jeff Gray writes that following the Superior Court of Ontario decision to grant super-priority to pension fund shortfalls “appeared to give hope to others stuck in the same situation. But it set off a firestorm in the world of bankruptcy lawyers…They warned that reversing the pecking order and putting pensioners ahead of other creditors would make it harder for companies to get financing. They also went straight to work, crafting fine-print escape clauses or workarounds to mitigate the possible effect of the ruling on their financing deals.” (If the Supreme Court fails to rule in support of pensioners’ rights, Canada will continue to be one of the only developed countries in the world, which offers no protection of earned pensions and benefits; I can’t comprehend how judges and legislators in particular, and Canadians in generals can’t see that earned wages and pensions (which are just deferred wages) must be given priority over risk capital which is appropriately compensated for risk-taking! Here is further reading on the Indalex case from Cassels Brock’s summary of the Indalex case “Ontario court of Appeals gives super-priority to pension wind-up deficiency”.

On a somewhat related topic the Supreme Court of Canada has (surprisingly, at least to me) refused to hear the case of the Nortel’s long term disabled as reported by Robert Sibley in “Panel refuses disabled workers’ case”.

Kelly McPartland writes in “MPs defend their $804M in pension benefit…” that “MPs discover they can happily live with a report indicating Canadians now pay $5.50 for every dollar MPs and senators contribute to their own rich pensions.” (We don’t have to worry that MPs pensions will not be properly taken care of.)

Things to Ponder

In the Financial Times’ “Adjust for inflation for clearer view on prices”Jack Farchy argues that commodity prices are not really that high if you adjust them for inflation, especially if you “Look at commodities in inflation-adjusted, local currency terms for some of the world’s top consumers, and current prices don’t look nearly so scary… Indeed, the only major consumer where real prices are higher than their 2006-2007 average is the US.” So don’t count on “high” commodity prices in China/India/Brazil to dent demand from these countries which are “driving the global economy and the boom in commodity markets”.

In WSJ’s “Geithner wants global rules on derivatives” because “Without international consensus, the broader cause of central clearing will be undermined. Risk in derivatives will become concentrated in those jurisdictions with the least oversight. This is a recipe for another crisis.” He “urged global regulators to develop common standards to ensure banks trading in the uncleared derivatives market have sufficient collateral, or margin, to weather future economic crises…Just as we have global minimum standards for bank capital—expressed in a tangible international agreement—we need global minimum standards for margins on uncleared derivatives trades.”

In the Guardian’s “UN report call for regulation to curb speculators pushing up food prices” Phillip Inman reports that “Government intervention may be needed to burst the huge bubble that has developed in the price of commodities such as food staples and oil, a UN report says . Prices have rocketed in response to dysfunctional commodities markets, according to the report, which also disputes the view of many senior economists and central bankers that commodity prices have jumped as a result of a surge in demand.”The changing role of commodity markets, which are turning into financial markets, has enormous repercussions for the economy,” (Thanks to CFA Institute Financial NewsBriefs)

In the Financial Times’ “China investors: Beware of inequality” Edward Chancellor discusses the differences between good and bad inequality in the context of a new book by Branko Milanovic entitled The haves and the have-nots”. While “inequality begets savings which in turn generate capital investment and economic growth…There’s a darker side to inequality associated with rent-seeking, corruption and macroeconomic imbalances. “Bad” inequality soared in the United States before the financial crisis. Today, it threatens China’s path to economic prosperity…It used to be believed that inequality diminished as countries became richer… During the past 30 years, the top 1 per cent of the US population’s share of total income rose from 8 per cent to 16 per cent. During the same period, US median incomes have barely grown in real terms… Inequality in China, writes Prof Wang, “hampers justice, undermines economic efficiency and becomes a major factor for social conflict and stability”. Rising inequality proved to be an ill omen for the US in the last decade. Investors who are currently entranced by China’s growing fortunes should take heed”.

And finally, in the Financial Times’ “Beware the threat from cyberhackers” Gillian Tett discusses potential hacker threats to the financial system. She identifies four threats of increasing potential severity: criminals stealing personal information to steal money, ‘hacktivists’ attacking financial websites as political protest, criminal groups hacking “to gain information to use to front-run trades or rig the markets”, and potentially most damaging is the infiltration of computer systems to spark a wider market malfunction halt financial flows or simply wipe out assets on a large scale…to cause systemic damage”. She concludes with warning that “The tail risk of a cyber disruption to markets, in other words, cannot be ignored. Investors had better hope that the banks and exchanges are much better organized than Sony (the IMF and Canadian government); and, perhaps, keep some hard cash in the mattress.” (Now there is a scary thought.)


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