Hot Off the Web– February 14, 2011

Personal Finance and Investments

James Mackintosh in the Financial Times’ “The thumb doesn’t always rule”points out that those old rules of thumb don’t always work with examples from momentum investing and value vs. growth investing. “There is no contradiction between momentum – a short-term strategy – and the hunt for value, and both can work. Elroy Dimson, Paul Marsh and Mike Staunton, at the London Business School, point out that both have excellent long-term records. But both approaches also disappoint occasionally; value has been out of favour for three years, while a momentum follower would have lost half their money in 2009 in the US, leaving them down for the whole decade. Academics disagree on the causes of these anomalies. But their research demonstrates the risks of taking rules of thumb too seriously, or applying them too widely.” (Those tired of trying out the latest hot new schemes to investing, might consider a passive approach to investing.)

Luann Lasalle’s Globe and Mail article “Will you need $1-million to enjoy retirement?”is finally an article discussing assets required for retirement and retirement income needs from the perspective of your pre-retirement expenses coupled with expected lifestyle changes, instead of the questionable “income replacement rates” bandied about in most articles.

In the Globe and Mail’s “Don’t let devotion to RRSP distract you from paying off debt” Dale Jackson writes that “…paying down debt provides a return on investment that isn’t subject to taxation. “You have a guaranteed after-tax rate of return of whatever the interest rate is on your debt,” says Mr. Trahair. If that debt is a mortgage it also becomes equity on a house, and houses most often appreciate in value. The capital gain generated from the appreciation of a principal residence is not subject to taxation. He also points out that choosing to pay debt rather than make an RRSP contribution is not a missed opportunity. The allowable contribution for that year can be carried forward to future years. That tax advantage could come in handy down the road for young people who have not yet entered their high-income, high-tax-rate years.”

In WSJ’s “Building a cheaper annuity”Leslie Scism celebrates the new variable annuities which are constructed on low cost ETFs. This ‘innovation’ (if you can call it that) is a step in the right direction and does reduce somewhat the total fees associated with such type of structured products. However this is not real ‘innovation’, nor does it make the product suitable for human consumption. The 2.5-2.7% annual fee mentioned is still toxic to your wealth. (Real innovation would using a pure longevity insurance product (i.e. single premium of $1 at age 60-65 to buy a lifetime income stream of $1 starting at age 85, using about 7% of one’s assets) available from a number of insurance companies, and managing the rest of the assets at <0.3% annual cost with a suitable asset allocation and decumulation plan. This does exist in the US (not Canada), but you hear it rarely discussed; I guess the commissions associated with this approach must be much lower than with variable annuities.)

The WSJ’s “Index funds get a makeover” is another article discussing indexes in the past two weeks (last week’s article was “Is your index fund broken?” ). Indexes discussed include: capitalization weighting (classical index), equal weighting and fundamental indexes, but many don’t consider the latter two as indexes but more of a form of active management; in fact the article suggests that the reader just consider them as a continuum starting with cap-weighted index at one end, all the way to actively managed funds. The author concludes with the comment that “A market-cap-weighted index fund is likely to beat an alternatively weighted index fund when large-cap or growth stocks are in favor. An equal-weight index fund should win when smaller stocks are hot, or certain sectors outperform. And a fundamentally weighted index fund should shine when smaller-cap and especially value stocks are in vogue.” Another article discussing fundamental indexes is Steve Johnson’s Financial Times “Investors weigh virtues of fundamental model”. In it he quotes a couple of experts essentially expressing the view that “Any wholesale adoption of fundamental measures would run into practical problems, however, if battalions of investors all tried to access the debt of highly rated entities that had little outstanding issuance.”

In the NYT’s “A retirement program for the risk-averse” Tara Siegel Bernard looks at Laurence Kotlikoff’s enhanced ESPlanner retirement planning tool for the ultra-conservative investor which includes a worst case view assuming that all risky assets will be lost. “The point of the program…is to establish a stable, guaranteed standard of living over the course of your entire life by showing you how much to save and spend. So the program only allows you to spend the money it considers safe  — that is, money not in stocks. It also shows the probabilities that you will have more money to spend each year, and how much.”. (Certainly a different approach…I haven’t used ESPlanner in anger and haven’t even looked at this new feature.)

Canadians Securities Administrators has a list of “Alerts, Warnings and Disciplined Persons”in the financial services industry in Canada which may be of some use to readers who are searching for or working with financial advisors (Recommended by Rob Carrick)

Chris Farrell’s BusinessWeek article “Rethinking stocks for the long haul” discusses the risks associated with stocks even in the long run and the implications thereof on some of the heavily equity weighted target-date funds. (If you are interested in the subject you might also want to read my Time Diversification blog discussing the subject.)

In the Globe and Mail’s “The investment account that can save you from yourself” Tracy Tjaden discusses the virtues of wrap accounts, now commonly offered by brokers. She quotes an industry expert that “Of all of the wraps’ selling points – transparency of fees and investment activity, automatic rebalancing, manager selection and the simplicity of one statement – auto-rebalancing is the key …” (The article has no mention of investment policy statement(IPS), financial plan…yet costs mentioned range from 1.65% to 2.1%…wrap-accounts may be directionally right but as it is, it’s not even close…close would say Initial IPS=$xxx, annual IPS re view=$xxx, asset management in compliance with IPS=xxxxx…pretty simple….fee for service….pay for value…)

Rob Carrick in the Globe and Mail’s “Look at ETFs to hedge against rising rates” explores some bond ETFs that might be useful to “protect the bond side of your portfolio from the threat of rising interest rates”. (I’d avoid some of the more esoteric ones (e.g. inverse/Bear funds) but you might consider looking at some of the low cost short-term or target maturity ones mentioned and compare them to what might be available in returns from GICs.)

Real Estate

In WSJ SmartMoney’s “Why you should buy that home now”AnnaMaria Andriotis looks at some of the reasons why, if you are planning to buy a home in the US, sooner might be better than later, even though home prices might decline further. Some of the reasons mentioned include: reductions in maximum size of government insured mortgages, higher fees, larger down payment requirements, rising mortgage rates, possibility of government might exit mortgage insurance business.

In the WSJ’s “Home affordability returns to pre-bubble level” Nick Timiraos writes that based on the ratio of median home prices to annual household income, housing affordability in 47 of 74 markets looked at has returned to pre-2003 levels. The ratio nationally dropped from 2.3 in 2005 to 1.6 in September 2010. But while affordability is there, getting a loan may be difficult and the house price decline has left 27% of the homeowners with a mortgage underwater. Using another measure of affordability“the price-to-rent ratio—the price of a typical home divided by the annual cost of renting that home—prices are fairly valued, or undervalued, in around 20 markets. Nationally, the price-to-rent ratio stood at 14.85 at the end of September, above the 1989-2003 average of 12. The data suggest pockets of the country have further to fall.”

In the Financial Post’s “Canada is ‘a purely random success story’ Shiller”Janet Whitman writes according to Robert Shiller the Canadian “housing market looks due for a U.S.-style drop; and, without oil, the country would be in trouble…(and)… Canada’s robust financial health compared to other nations is largely due to a random run-up in oil prices in the midst of the global financial crisis.” (i.e. we shouldn’t be too smug about it but should at least enjoy it without guilt.)


Pauline Skypala, in the Financial Times’ “DC looms for public sector pensions”looks at data from a recent Towers Watson report on global pensions. “Defined benefit schemes hold 56 per cent of the $26,000bn invested in pension schemes worldwide. But that is down from 65 per cent in 2000.” Australia has81% of pension assets in DC plans, US 57% and UK 40%; however DC plans in Japan, Canada and the Netherlands account for only 2%, 5% and 6%, respectively. The difference is in part explained by the fact the in Japan and Canada “public sector pension assets make up 70% and 62% of the total. If public sector pensions would use realistic discount rates for pension plan liabilities contribution rate as a percent of payroll would have to rise in Canada from 20.1% to 45.5%!!!. “…the cost of providing final salary pensions in the private sector has been made apparent through greater transparency. There are ongoing arguments about whether the accounting methods used to value the assets and liabilities of schemes are sensible ones, but the trend to DC appears irreversible, for good or ill. If the public sector adopts similar transparent accounting methods, it will be hard to make a case for the status quo there.”

Things to Ponder

In the Financial Times’ “Stock picking poised to return”Jack Mackintosh argues that “This week the rolling 50-day correlation of stocks in the S&P 500 with the index hit its lowest since June 2007, falling from 23-year highs last summer. This is another sign that markets are getting back to normal. Companies are once again being valued on their prospects, not just the global economic outlook. This gives fund managers an opportunity to shine – or muck things up.” (I wouldn’t count on retail investors to pick the managers who will beat the market before fees and certainly not the even smaller number who’ll beat the market after fees. So I would just stick with broad based indexes in each asset class.)

In the Financial Post’s “Give the middle class a break”Jack Mintz says that the governments should stop focusing on corporate tax reductions, and instead focus on reducing taxes on labour. “High public spending means that governments end up taxing many people too highly, hurting productivity and economic growth. .. Canada’s average marginal tax rate on labour has hardly budged in the past five years, falling to 45.4% from 46.5%…governments never see a good time to cut personal taxes…As soon as fiscal surpluses appear, politicians look for new programs to reward their voting constituencies. “

Neither Jonathan Chevreau in the Financial Post’s “Read between the literacy lines” nor Rob Carrick in the Globe and Mail’s “The lost key to financial literacy: Better disclosure” are particularly impressed with the composition of the financial literacy task force or its recommendations. Carrick writes “it’s disappointing to see banks, advice firms, investment dealers and mutual fund companies treated solely like part of the solution to the lack of financial literacy in Canada, and not part of the problem as well”, and he suggests that the task force failed because it did not address the issue of better disclosure. Chevreau is sceptical as well when he writes “I question the lip service and bandwagon-jumping the financial industry has shown to “finlit” so far. Just as Ottawa saves money when seniors fail to collect benefits to which they’re entitled–see story at right–I wonder about the financial industry’s motivation to open its customers’ eyes…I hate to rain on the parade but financial industry profits are made on the backs of financial illiterates”. (Both of their assessments are that little good will emerge from these recommendations. My take is unchanged; the industry needs a shift to the fiduciary model discussed in my last week’s blog on this subject Fiduciary.)

In the WSJ’s “How now, 36,000 Dow? The ominous undertone of rallies” Jason Zweig writes (in reference to a new book by the author of the 1999 book “Dow 36,000”) that “Economists contend that riskier assets must offer higher returns, or no one would invest in them. That is a fallacy, says Howard Marks, chairman of Oaktree Capital Management in Los Angeles, which manages more than $80 billion. Mr. Marks is author of a superb forthcoming book, “The Most Important Thing,” that helps explain risk clearly. Riskier assets don’t necessarily offer higher returns, Mr. Marks says; they only appear to do so. “It’s really simple,” he says. “If risky investments could be counted on for higher returns, then they wouldn’t be risky. And if investments weren’t risky, then they probably wouldn’t appear to promise higher returns.”… But by Mr. Marks’s common-sense definition of risk—”the likelihood of losing money”—rising prices are pure investment poison. The higher and faster prices go up, the farther and harder they have to fall… Meanwhile, cash is moving out of municipal bonds and emerging-markets stocks as their prices fall. If that keeps up, they will get less risky, not more—and more attractive, not less.”

In the Financial Times’ “Entranced by China’s bubbling economy” Edward Chancellor discusses a Mansharamani’s new book “Boombustology” and writes that “All great bubbles have easy money and growing leverage. Mr Mansharamani turns to Friedrich Hayek and the Austrian economists to show how inappropriately low interest rates fuel credit growth and over-investment. Behavioural psychology also helps explain why bubbles develop. Humans have a chronic tendency to overconfidence. We underestimate the probability of events that we haven’t recently experienced (what’s known as the “availability heuristic”)… the speculative crowd follows a trail of recently minted money. Politics provides yet another prism for identifying bubbles. Great speculative booms are often stimulated by governments, sometimes with the intent of lining the pockets of public officials. All bubbles are accompanied by fraud… China’s asset price inflation has been driven by artificially low interest rates, which is contributing to a massive misallocation of capital into investment projects with palpably low returns.”

CARP Advocacy in “Non-profit or for-profit? Quality in Long-Term Care homes” reviews a recent study on Residential Long-term Care for Canadian Seniors which predicts that an increase from the current 200,000 to 320,000 LTC beds will be required in Canada by 2041. The authors of the report then look at the differences in the quality of care (at least as measured by staffing levels) and they conclude “that for-profit facilities are likely to produce inferior outcomes to not-for-profit homes.” The report’s authors then proceed to argue that “the true question of quality has more to do with enforceable standards and regulations than type of ownership. Accordingly, many of the recommendations offered by the study indicate that government can ensure quality, independent of ownership of the homes. For one, the authors recommend legislated minimum staffing levels be adopted. They also argue for implementation of regular unannounced inspections conducted by trained inspectors.

In a (somewhat related) Barron’s article entitled “Profit: The right standard for business” Tibor Machan argues that “What needs to be upheld in the field of business ethics is the principle that ownership confers the rightful authority to allocate resources and wealth. There should be no question-begging presumption that companies must serve society…The decision on how profits should be used should be left to those who earned them.” (So you might want to ask the question in context of LTC facilities where physically and/or mentally incapacitated individuals are involved or in the asymmetric informational world of the financial industry vs. a retail investor, whether for-profit or non-profit businesses are more appropriate to provide the required services, whether it is possible and if there is the political will to establish regulatory standards and enforcements to protect the average citizen when they are in a position of informational/physical/metal asymmetry relative to those who are in a position to exploit that asymmetry; in fact you can ask whether government has a role to play in protecting citizens in such situations and if yes how that would be paid for, or perhaps society needs to retreat to mutual aid and family support structures?)

And finally, the Economist’s Buttonwood in “Is Malthus back?” quotes a Barclay’s Capital report that “Malthus may turn out to be right, but with broader implications than he may have imagined…(adding that)…We are depleting the global stock of natural resources, i.e commodities in the broadest sense of that term, at an accelerating pace, with the rise in per capita commodity consumption vastly accelerated by rising prosperity in the developing economies.” Buttonwood adds that “The key factor is that US demand is no longer crucial for setting the global price of all commodities….(The real driver is emerging markets’ demand)…A fall in US demand thus does not automatically lead to a fall in price. In effect, this is a supply shock for developed economies and a supply shock is always negative.”


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