Hot Off the Web- August 18, 2009

Back from holidays and ready to roll again. In the next few weeks, in response to some reader requests, I plan to do some special topic blogs on: asset allocation, a quantitative look at the value of LTCI (long  term care insurance) and the impact of savings rate, asset allocation, inflation and rate of salary increases on the number of years to retirement and corresponding retirement income. In the meantime here is the latest Hot Off the Webarticles accumulated over the last two weeks.

Personal Finance and Investments

Financial education programs are generally aimed at the young with the objective of accumulating retirement savings. (Not that this is done particularly well.) WSJ’s Ruth Mantell discusses the need for financial literacy of seniors in “Making seniors more money savvy”.  Some of the expert advice recommended for seniors includes: delaying retirement, assessing one’s longevity risk,  scams are everywhere so don’t release control of your finances to anyone (other than your children), find the right balance for your expenses (overspending you can run out of money, while under-spending short-changes your lifestyle).

Tom Lauricella  in WSJ’s “Retiring? Pay off your mortgage”tackles head on the inadvisability of entering retirement with a mortgage.  A combination of falling real estate values, little opportunity to earn interest (especially after-tax) on cash or bonds, the risk associated with the higher expected returns of equities, all lead to “The bottom line is that for those nearing or in retirement, it’s very, very important to be conservative when it comes to protecting home equity…it can be a real crucial bridge later in life, and without it you can end up in a really tough situation.”

Tom Cestnick in the Globe and Mail’s “Checklist to help unwinding an estate”suggests the following checklist of financial issues to be dealt with when somebody passes away: funeral arrangements, locating the will, identifying assets and insurance policies, tracking down bank accounts, government benefits (CCP death benefits, survivor’s pension, children’s benefits), registered plans (RRSPs, RRIFs), cash/debt managements, visit advisors and Cestnick then finishes off with “Don’t make any big financial decisions immediately after the death of a very close loved one. Give yourself up to a year before selling your home, or making other decisions that will affect you significantly. “

In WSJ’s “Can the Supreme Court undress high fund fees?” Jason Zweig discusses a case before the Supreme Court challenging (U.S.) mutual fund fees of about 1.1% (which are less than half the typical Canadian mutual fund fees) as being too high and that fund board of directors, who are in conflicted position, are doing an inadequate job at policing the level of fees. (I find it amazing that Canadians still continue buying mutual funds with management fees of 2-3% rather than simply switching to indexed ETFs often an order of magnitude cheaper!?!)

In the Financial Post’s “Wake-up call for financial advisors catering to the wealthy” Jonathan Chevreau refers to a blog by Dan Richards who identifies three recent articles about dissatisfaction among high-net worth investors with their advisors. These investors are increasingly seeking second opinions, or switching from Wall Street brokerage (using so called suitability criteria) firms to independent advisors (with fiduciary responsibility toward the clients)  or are moving  to discount brokers.

In a related article Tom Bradley in the Globe and Mail’s “Clients should take the reins in setting bonus payouts” discusses compensation (bonuses) in the financial services industry. He argues that investors should be prepared to pay higher fees for: star portfolio managers with track record and who can handle only handle limited capacity of assets (e.g. small cap, real estate, private equity). “But there are still far too many instances where clients overpay needlessly to have their assets managed. Canadian investors are still paying 2.5 per cent to own mutual funds that do little more than mirror the index.” Investors should make sure that that they don’t get overcharged for ‘beta’ (market indexes available in ETF form for 0.1-0.3%/year). “In performance-based fee arrangements, investors often accept too generous a base or minimum fee. Asset managers who want a piece of the upside should have to share in the downside too.” Bradley argues that clients have power to demand reduction in inappropriately high bonuses and management fees.

Investors should watch out, reports Steve Johnson in the Financial Times’ “Latest complex ETFs test faith in banks”. Banks and asset managers are getting anxious about the growth of assets in ETFs. “The original premise of these devices (ETFs) was investors could get cheap, transparent, diversified, liquid exposure to mainstream asset classes in a pleasing variety of locales. But that was always going to be far too simple for the ever inventive minds of the financial industry.” So now we have: leveraged, inverse, commodity, (believe it or not) ‘faith’-based ETFs and worried banks “fearful for their margins in a world in which ETFs and other forms of low-cost passive investment are increasingly king, are fighting back by wrapping ETFs in fiendish structures.” The structures proposed occasionally bring promised benefits, such as downside protection, but more often than not the benefits are not there or are significantly eroded by high fees. Johnson closes the article with “it is hard to get around the perception that much of this complexity is not necessary, and is more a case of smoke and mirrors designed to deliver both an information advantage and a more generous pot of fees to the minds that dreamt up the devious devices…(and) Investors instead need to look out for their own interests and follow one of the few meaningful mantras of the investment game; if you don’t understand it, don’t buy it.”

Real Estate (U.S., Florida)

Damien Cave in the NYT’s “On the mat, Florida wonders which way is up” reports on Florida’s falling property price induced economic meltdown. There is discussion of the search for solutions, the disastrous politicians and lobbyists but as one individual quoted suggested “We need to do something bold, we need to do something radical,” adding: “Everything is going to be O.K., but not if we do it the same way.” (There is however no mention of Florida’s discriminatory property taxes. Non-homesteaded, part time (winter) resident property owners pay 2x or 3x or 4x or more times the property taxes compared to long-time homesteaded property owners even after property values have dropped by 30-50% over the last 3 years. Many people, who don’t use Florida’s services 8 months a year and don’t have children in Florida’s schools, still have been paying $8,000-12,000/year in identical condos where their homesteaded neighbours pay $2,500. Florida’s so called Save-Our-Homes constitutional amendment makes Florida the rip-off state of the USA. You will know that Florida is ready to make real changes, when you hear about equal treatment of out of state property owners in Florida. Until that happens, you better go in there with open eyes or you’ll be taken for a ride.)

Also in the NYT is Paul Sullivan’s “There is value in real estate, if you find your Florida” who argues that “with 78 million baby boomers expected to retire in the next two decades, the state’s long-term prospects are solid: a good proportion of them will want to be someplace warm and sunny when they stop working.” His article discusses residential and commercial property, the importance of considering fixed costs and if you dive in, you should have a very long horizon (10-15 years) in mind.

U.S. foreclosures are continuing to rise, as described in Dan Levy’s Bloomberg article “U.S. Foreclosure fillings set third record-high in five months”  (weak demand, falling prices, 25% of mortgage holders underwater). The list of ‘top 10’ foreclosure states are led by Nevada, California, Florida and Arizona. Even more disconcerting is the Mary Shanklin Sun-Sentinel article “Foreclosed homes: Forsaken and now frightening” whose subtitle “Foreclosed homes are rotting away- and stripped bare” tells the reader that the earlier “unkempt yards are the least of residents’ concerns.”

And for those looking for a quick recovery in home prices Brett Arends WSJ article “Home prices: There is no quick recovery ahead” suggests that while we may be near the bottom (in the U.S.) caution is required due to: hidden inventory of unsold houses (now rented), high unemployment, high household debt and because renting is still cheaper than buying in many markets. “A real-estate purchase needs to make sense on its own terms. And measure it on cash flow today, not the hope for capital gains tomorrow.”

And speaking of renting Thomas Sugrue’s article “The new American dream: Renting” in the WSJ suggests that the multi-generation long American dream and promise of home-ownership may start reversing. Renting is still more common in countries like France, Switzerland and Germany. U.S.’s upward trend in home ownership was largely driven by government programs. During the last decade “the dream of home ownership turned hallucinogenic. The home financing industry—at the impetus of the Clinton and Bush administrations—engaged in the biggest promotion of home ownership in decades. Both pushed for public-private partnerships, with HUD and the government-supported financiers like Fannie Mae serving as the mostly silent partners in a rapidly metastasizing mortgage market. New tools, including the securitization of mortgages and subprime lending, made it possible for more Americans than ever to live the dream or to gamble that someone else would pay them more to make their own dream come true. Anyone could be an investor, anyone could get rich. The notion of home-as-haven, already weak, grew even more and more removed from the notion of home-as-jackpot.” “James Truslow Adams, the historian who coined the phrase “the American dream,” one that he defined as “a better, richer, and happier life for all our citizens of every rank” also offered a prescient commentary in the midst of the Great Depression. “That dream,” he wrote in 1933, “has always meant more than the accumulation of material goods.” Home should be a place to build a household and a life, a respite from the heartless world, not a pot of gold.”

(Canada’s) Pension Crisis and Reform?

A significant number of articles appeared in the Canadian press over the last two weeks about the need to solve the country’s pension crisis.

Jonathan Chevreau’s Financial Post article “The ABCs of pension reform in Canada”discusses the scheduled Federal and Provincial Finance Ministers’ December 2009 meeting on pensions, following the various provincial pension studies and recommendations over the past 2-3 years. In the article he suggests that the future may hold a “hybrid DB-DC plan that gives workers an expectation, but not a promise, of future investment returns”, but unions (especially public sector ones) are getting ready to  fight to prevent loss of their indexed (up to) 70% of final pay pension plans.

In a related story (brought to my attention by KK) in the Progressive Economics Forum in the article entitled Jack Mintz, Research and Pensions, Andrew Jackson writes “It is a bit stunning to discover that Jack Mintz – former head of the CD Howe Institute and now at the University of Calgary – has been appointed research director of the federal – provincial review of pensions. Even Finance Minister Flaherty should be a bit embarrassed to appoint as a “researcher” someone who is so strongly on the record as a fervent defender of individual responsibility for retirement savings and the virtues of RRSPs” and “Jack Mintz are squarely on the public record as an opponent of new public pension plans”. Some would say that ‘stunning’ is an understatement, ‘misinformed’, ‘he just doesn’t get it’ or perhaps even ‘outrageous’ would be more appropriate characterizations to this appointment. (You might also want to read my blog,  “Jack Mintz: Beware of the super pension fund”-NOT, of around April of this year on a Jack Mintz opinion piece in the Financial Post at that time. You should send letters to Finance Minister Flaherty, Prime Minister Harper and letters to the editor expressing your disapproval of having such an appointment to what is inappropriately labeled as a “research” on pensions given Mr. Mintz strongly expressed public views. This is truly scary! Given insurance industry opposition and a biased pension advisory/”research” group is not a very promising start to the December pension summit.)

Also in the Financial Post is Karen Mazurkevich’s “Rethinking Canada’s pension problem” where she mentions the appointment of Ted Menzies as “the government’s face of pension reform”. She reviews various options under discussion: a CPP based target (rather than defined) benefit hybrid DC-DB plan (opposed by the insurance industry), life insurance companies’ proposal for “multi-group DC plan” (many question whether the insurance industry, given its track record, would manage the assets in the best interest of the investors) and the so-called “uber-funds”, some of Canada’s largest funds (Ontario Teachers’, OMERS) which promise better and cheaper models with economies of scale. The Globe and Mail’s Tara Perkins reports in “Life insurance industry pushes pension fix” specifically on the opposition of life insurance companies against national and/or provincial plans. Note that even an insurance company of ManuLife’s stature is not immune to effects of market volatility and bad judgment- see Globe and Mail article “Manulife’s choice: Safety first”. By the way the problem results from the lose-lose GMWB (GMWB I , GMWB II) products that they have been aggressively/successfully peddling in the US and Canada over the last 3-5 years.

Globe and Mail’s Terry Pedwell reports in “Pension-plan fund shifts legitimate, top court rules” that Canada’s Supreme Court ruled last week that the Company (the pension plan sponsor) can divert surplus in a pension fund (from DB to DC plans in this case)! However, the BIA does not protect pensioners under bankruptcy proceeding when a private sector DB plan is underfunded; not all is right in Camelot. Why don’t pensioners’ legal representatives go to the courts, and if necessary to the Supreme Court, to argue for the protection of pensioners when the plan is underfunded? While I am not normally a strong supporter of the union movement in general, it is difficult not to agree with the CAW when they say that “Bankruptcy law is designed to protect the banking and money lending system; it is not designed to protect those who have given their lives to the service of a company” in their recent website post.

In closing on Canadian pensions Jonathan Chevreau reports that CARP “is calling on politicians to protect the retirement of its members or “we’ll help you to yours [Retirement].”” in  “CARP tells politicos to fix boomers’ retirement or voters will retire them”. (How true!)

Things to Ponder

The Financial Times’ John Authers discusses the tug of war between “deflationinsts and inflationinsts” in “Deflation persists”. He argues that over time both could still be right; deflationists in short-term and inflationists in the longer term. “The initial deflationary shock could give way to inflation. But much depends on timing. Deflation is persisting longer than some inflationists had expected.”

In the Financial Times’ “Future tips from past clairvoyants” Rob Arnott argues the case for value stocks by indicating that the growth stocks are priced at an unprecedented (except in 2000 tech bubble) 2.5x the multiples of value stocks. “Either the market is right or the market is overconfident in its ability to discern future growth opportunities. If the latter, what a time to buy value stocks. And, what a terrible time to bet on growth. “

You might also find interesting behavioural finance guru Richard Thaler’s Financial Times article “Markets can be wrong and the price is not always right” . Here he discusses some recent lessons associated with the efficient market theory (EMT) which he defines as “the price is right” and “there is no free lunch”.  The lessons learned “On the free lunch component there are two. The first is that many investments have risks that are more correlated than they appear. The second is that high returns based on high leverage may be a mirage.” (Worth a read.)

Jason Zweig in WSJ’s “Data mining isn’t a good bet for stock market predictions”explains the difference between correlation and causality. He also defines data mining as “The stock market generates such vast quantities of information that, if you plow through enough of it for long enough, you can always find some relationship that appears to generate spectacular returns — by coincidence alone. This sham is known as “data mining.”” He then proposes some rules that you can use to prevent you from falling into a “data mining” trap: (1) do results make sense? (2) “Divide data into thirds to see whether the strategy did well only part of the time”? (3) impact of trading costs, management fees and taxes on the outcome? And (4) don’t rush, if strategy is worthwhile it will still be so in six months.

How low have we sunk: With the recent uncovering of a number of small and large Ponzi schemes, Gregory Zuckerman in WSJ’s “For group of sceptics, the truth is out there”reported on a recent gathering of the Association of Certified Fraud Examiners which he characterizes as an organization whose outlook is  “There are only two types of people: the caught and the uncaught”

And finally, a couple of (non-financial) healthcare related articles: the first is WSJ’s “Obama’s senior moment”  where  it is suggested ObamaCare’s effect is expected to be “once health care is nationalized, or mostly nationalized, rationing care is inevitable, and those who have lived the longest will find their care the most restricted.” (Now here is an area that we in Canada are already ahead of the U.S.) and a report “Multinational comparisons of health systems data, 2006” which contains some very illuminating statistical comparison of Canadian health care with other developed countries.