Hot Off the Web– December 16, 2009

Personal Finance and Investing

Jonathan Chevreau writes in the Financial Post’s “Funds should serve clients not advisors” . Now that’s a refreshing thought! This discussion in Chevreau’s blog was started when one of the mutual fund companies initiated a new fund which just acted as a wrapper around some ETFs, to make them sellable by their mutual fund sales channels (because these channels are not licensed to sell ETFs.) He quotes fee-only planner Mike Macdonald that “Trimark’s new approach is a very clear message that investors’ needs are not even on the radar screen when it comes to new fund criteria. The litmus test is clearly ‘Can advisors push this?’, followed by ‘Will Advisors feel incented?’ If the answer to both is ‘Yes,’ a new fund is born.” Another advisor “characterizes trailers as “bribes” and calls for a shift to fee-based accounts”. (Sounds sensible.)

The WSJ’s Kelly Greene discusses the 2010 opportunity for U.S. investors to convert their tax-deferred investment accounts to tax pre-paid accounts in “Why it may pay to convert to a Roth IRA”. She discusses the pros and cons of doing this in addition to the usual considerations like potential/expected tax rate increases; other reasons mentioned are: control over assets (no required minimum distributions) and some even argue that it makes sense to convert even if you have to pay the taxes from inside the IRA (so later on one’s income remains below levels where Social Security is taxed or higher Medicare rates are applicable). Greene suggests professional advice in making the decision.

Barron’s Mark Veverka reports on something different in “In lockstep with geniuses” on a start-up kaChing offering a new online service allowing one to invest along-side with ”geniuses” selected by kaChing, by automatically or manually mirroring their portfolios. “One of the many innovations that kaChing brings to the investment industry is online transparency, which includes enabling investors to see every trade that a portfolio manager makes just moments after the trade clears — not just a snapshot at the end of a quarter….Fees start at 1.25% for automatic execution which tracks the selected “genius” and is free to track manually…” (Hmmmm…interesting there are lots of new ideas around, time will tell which one actually offer value to the investor….not sure about this one.)

Jason Zweig in WSJ’s “Reach for stock yield, and you might get bit” reminds readers that “income isn’t interchangeable; a 4% yield on bonds isn’t the same thing as a 4% yield on stocks. Bonds are risky too, especially at today’s high prices. Stocks, on the other hand, can fall hard even when they pay high dividends….The whole point of holding bonds and cash is to provide income and safety to temper the risks elsewhere in your portfolio, like the risks of owning stocks. No matter how fat a dividend they offer, utilities and other high-yielding stocks are still stocks. Preferred stocks, convertible bonds and junk bonds behave like stocks.” (Sound advice. Watch the overall risk level of your portfolio!)

Real Estate

First on the Canadian real estate front the Financial Post’s Iam McGugan quotes the Cleveland Fed in “Why didn’t Canada’s housing market go bust?”that Canada’s “lack of a subprime lending industry…kept the housing market in this country from imploding”. Though McGugan is not satisfied with this explanation since it did not answer the question whether the Canadian “market will go bust in the future.” “U.S. home prices doubled from 2000 to 2006, then tumbled. They are now about 40% ahead of their 2000 levels. In Canada, home prices staged a more sedate takeoff and didn’t hit a peak until 2008. They’ve come down only slightly and are still more than 75% ahead of their 2000 levels.”

Similar theme emerges in Steve Ladurantaye’s Globe and Mail article “Merrill warns of housing trouble” . Merrill analysts suggest that as a result of “decades low” mortgage rates Canadian housing prices may be approaching bubble levels. They also suggest that the culprit may be “policy errors” resulting from Canada’s inflation rate being underestimated due to the way Bank of Canada calculates it, by “ignoring the red-hot (house) resale market”. In another article, “Home sales surge 73%”, Ladurantaye reports that, according to CREA, Canadian real estate prices in November are up 19% year-on-year and sales increased +73%. Obviously these numbers are being compared to a “trough” last year. Economists are worried about the sustainability of the price increases given the dropping affordability of homes.

In the U.S. the story is still not improving much. Fortune’s Beth Kowitt writes in “Housing outlook for 2010”that things may be even worse than they look. She quotes Moody’s Mark Zandi that “Home prices are going to fall 5% to 10% more — and over 30% in places like Miami — between now and this time next year. Then they might start turning around. (Emphasis on “might.”).” This is due to high level of banks’ inventories of foreclosed homes so far held off the market and the further 2.4M of additional foreclosures expected next year. Florida, California, Nevada and Arizona are most exposed. However even bargain basement prices may not bring out enough buyers due to “sky-high unemployment”.   He concludes with “there’s almost zero possibility of another U.S. housing bubble anytime soon.”

In “American dream 2: Default, then rent” the WSJ’s Mark Whitehouse looks at people who as they “quit paying their mortgages and walked away from their homes, they’ve discovered that giving up on the American dream has its benefits.”  In fact they are finding that the new American dream is, renting. The economy however may benefit, since consumers have more cash to spend on non-housing items. One economist quoted suggests that this is a “stealth stimulus…the quicker these people shed their debts, the faster the economy is going to heal and move forward again.” (You have to remember that in the U.S. the mortgage issuer cannot pursue the borrower for other assets beyond the mortgaged home.)

In the meantime the Sun Sentinel’s Paul Owers reports that “Florida has second highest foreclosure rate”. Nevada is #1 with 1 in 119 homes in foreclosure, while Florida is #2 with 1 in 165. Foreclosures in South Florida are still “rising but at a slower rate than the first half of 2009”; this is due to banks’ greater willingness to engage in short sales, which they consider a less onerous process than foreclosures.


In the Globe and Mail editorial “Two-tier pensions”, the Globe comes down squarely in favour of Mr. Ignatieff’s proposed supplementary national pension plan. The Globe sees the value for the 75% of the private sector workers who don’t have a pension plan. A voluntary nationally administered and professionally managed plan should result in better returns and lower costs. (The Federal government, no doubt encouragement from the active lobbying by the financial services industry, may not be ideologically inclined to initiate such an approach, though many observers suggest that if Mr. Harper fails to act, many provinces will go it alone with similar solutions. The time to act is now (actually it’s already late); we’ll get some indication this weekend from the outcome at the Yellowknife pension summit.) The Globe also endorsed the transfer of bankrupt companies’ underfunded pension assets to managers such as CPP. (Of course pensioners are also looking for increased priority in bankruptcy court relative to other unsecured creditors; this would go some way toward dealing with Canada’s inadequate pension insurance when compared to other developed countries.) (Thanks to U of T Rotman School’s Keith Ambachtsheer for bringing this editorial to my attention.)

Janet McFarland, in the Globe and Mail’s “Ontario unveils pension reform”, reports on the first phase of Ontario’s pension reforms. I read and re-read how this might help solve the crisis that current pensioners have as a result of sponsor bankruptcy or for that matter how these reforms might help next generation of pensioners, but these considerations appear to have been saved for a future phased two. McFarland’s comment is “But the new legislation is most notable for the high-profile issues that are not mentioned – including questions about expanding pension coverage to more workers without workplace pension plans, which is scheduled to be discussed by provincial finance ministers at a summit in Whitehorse next week. It also is silent on proposals to assist retirees whose pension payments are reduced when companies declare bankruptcy with a shortfall in their pension plans.” I guess we’ll have to wait some more to get to the meaty reform proposals. Perhaps, these will be disclosed at the coming weekend’s pension summit.

The Financial Times’ Norma Cohen writes in “Regulators warn over pension lump sums”that “Transfer values have long been a touchy subject for the actuarial profession which remains deeply divided over how these should be calculated.  At the heart of the debate is the fact that there are no clear rules on calculation and actuaries are not required to use prudent assumptions – or indeed, even realistic ones – about key drivers of value such as future investment returns, interest rates, inflation or life expectancy.” (These comments appear to be in the UK context, but apply to Canada based my understanding on reading the Nortel valuation report prepared by its actuaries. This must be ripe for massive regulatory change, but there appears to be little discussing on the subject.)

Dan Richards had a couple of articles in the Globe and Mail on pensions. The first, “Let’s turn down the panic on the pension plan problem”, suggests that Canada’s pension system is not in crisis and not in urgent need for action; he wrote that all we need is “to turn down the rhetoric and turn up the substantive discourse.” Obviously his pension must be from U of T and rather than Nortel, Abitibi or even Air Canada or Ford. One point in the article was certainly true. This is a problem that has been festering for years and nothing was done about it. And just because it was festering for years it doesn’t mean that there is no crisis. In fact there is a crisis because of years of neglect on part of at least some of the parties who had fiduciary and/or professional responsibilities toward pension plan beneficiaries or were elected to protect the Canadian public.  His second article a week later (more than likely after much negative feedback to the first), is a better reasoned “A fundamental rethinking needed on pensions” where he recommends a solution to the pension crisis, like the Ontario Teachers’ Pension Plan where risk is shared between employees and the government (sponsor). (Great idea, except for at least one (actually quite a few more) little thing(s), a private employer sponsor can still go bankrupt and not pay its half of the bills, whereas the government (the taxpayer) will pay; oh well, back to the drawing board. The other ‘minor’ consideration is that this does not solve any of the problems associated with the current commitments of existing pension plans.)

Things to Ponder

I the NYT’s “Recession elsewhere, but it’s booming in China” Keith Bradsher writes that “For the first time, Chinese will buy more cars this year than Americans.” The same true in many other consumer goods: refrigerators, washing machines and computers. “Retail sales growing at 17% a year. While volumes exceed American volumes, “the average price tags on most Chinese products are much lower…(so) the total dollar value of sales in China is still smaller than in the United States”. However China doesn’t buy much in American exports, so most of the benefits go to commodity producers. While some wonder about the sustainability of the blistering growth rate, others are predicting a 12% per year growth in China’s economy for at least the next two years.

With the imminent arrival of the second decade of the 21st century, the Financial Times’ Aline van Duyn reports in “The lost decade for US stocks”that in the first decade “risk has not paid off. According to analysis by Gerstein Fisher, taking the annualized return on the S&P 500 and subtracting the rate paid on Treasury bills, there have been no benefits to taking equity risk. Indeed, there has been a negative annualized reward, of minus 3.4 per cent, in the past decade.” “There have been three other decades in the last century where equities have failed to deliver returns and Treasuries have done better: the 10 years leading to 1939 (minus 5.7 per cent), 1974 (minus 4.8 per cent) and 1982 (minus 3.6 per cent).” The following decade tended to be great for stocks (no guarantee for an encore). “But the only explanation for a repeat of the past decade for US stocks would be if Japanese-style deflation took hold.”

The Financial Times John Plender writes in “Currencies have their uses” that with asset classes not having delivered the promised diversification, he suggests looking at currencies as a means of diversification. While currencies are not really a true asset class, “currencies by definition cannot move in lockstep. If one goes up or down, it does so against something else.” The problem is that “since currencies have a knack of departing from economic fundamentals for unconscionable periods. That makes them a tricky means of diversifying – much more so than conventional portfolio approaches”. He concludes with “So, yes, currencies are a risky way to achieve diversification and no free lunch. But in a world where investors move compulsively in herds and the theory of diversification has flunked the test, they have their uses.” (My personal approach to currencies has been to build an asset class and geographically diversified portfolio, but leave it un-hedged thus getting the benefit/pain of the currency diversification resulting from the country/region diversification.)

Agarwal et al in a Brookings report entitled “Age of reason: Financial decisions over the life-cycle with implications for regulation” present data indicating declines in the cognitive functions of older adults. They also report on “lifecycle patterns” in financial mistakes, with middle-aged adults getting better financial terms than younger and older adults. A suggested explanation is that while experience rises with age, analytical capabilities decline. But the most interesting part of the paper pertains to regulatory levers which might be explored to protect people from becoming victims of these effects. Among the nine regulatory approaches mentioned are: libertarian paternalism (advice, defaults), “driving license” (i.e. to prove that you are qualified to make decision), increased level of fiduciary responsibility for sellers of financial products, mandatory advanced directives (before age 70), “protected assets” a lifecycle safe harbour (e.g. 50% of assets in certain types of retirement accounts must be invested at a specified age into low-cost annuities, bond or life-cycle funds), default regulatory approval (if product meets certain socially optimal standards), and requiring explicit regulatory approval for all financial products (costly). Interesting and in some ways scary reading. (Thanks to ken Kivenko of Canadian Fund Watchfor bringing paper to my attention.)

In the Financial Times’ “End bankruptcy priority for derivatives, repos, and swaps”Mark Roe writes that priorities for derivates in case of counter-party bankruptcy lead to moral hazard and “warp the financial industry’s incentives to avoid problems…if the derivatives and repo transactions were not so favorably treated in bankruptcy, financial players would seek other ways to protect themselves. That effort would channel them into stabilizing the financial system or at least into making sure they were dealing with stable counterparties.” (No doubt, currently these derivatives also come ahead of pensioners in bankruptcy situations.)

And finally, WSJ’s Alexandra Levit in “Coping with criticism” writes that “Putting yourself out there — in your career or otherwise — means that some criticism is bound to come your way. What’s really important, though, is not what is said but how you cope with it. Some people pretend it’s not happening. Others deny responsibility or respond by being defensive. People with the most successful careers, however, learn to listen carefully, accept constructive criticism, and look for ways to grow from it. …Instead of trying to avoid criticism, embrace it. “Approach all critical comments from the perspective of gratitude,” suggests Mr. Vaynerchuk. “They represent an opportunity to improve on an aspect of your job and will only help you in the long run.” In the spirit of Ms. Levit’s thoughts, I would be grateful to receive any feedback from readers of my blogs/website, in order to improve the value to the readership. You can send me your thoughts by clicking on Contact Peter


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