Hot Off the Web– October 18, 2010

Personal Finance and Investments

Christopher Condon discusses ETF originators’ competition in Bloomberg’s “Vanguard chips away at BlackRock (iShares), State Street in ETF price war”. After a late start in the ETF business, Vanguard is closing the asset gap with fees about half of those of BlackRock and other vendors. E.g. emerging markets EEM (0.72%) compared to VWO(0.27%) . (There are other reasons than cost to diversify your ETF suppliers, and lean to Vanguard, discussed in ETF Concerns: There are risks, but thanks I’ll stay with ETFs for my money , including that Vanguard alone, an investor owned mutual investment company, has only the investors’ interest as the exclusive priority over shareholders’.)

In the Journal of Financial Planning article “Weighing the risks: Are Exchange Traded Notes right for your clients” Smith and Small discuss the subtle but important differences between ETNs and ETFs, including: their structure (physical vs. derivatives), credit/counterparty risk (decreases with more frequent redemption dates), tracking error, and tax treatment. ETNs offer the only way to access some asset classes (e.g. some commodities, currencies, etc) for the retail investor. (A somewhat technical article but quite accessible if you’re interested.)

In the Globe and Mail’s “Watch out for tracking errors when buying ETFs” Rob Carrick reminds readers that in selecting an ETF to access an asset class, also consider tracking errors, since large tracking errors can negate any ETF cost advantages over mutual funds. Tracking error is a measure of how closely the ETNs track the target/underlying index. Differences in tracking error can be due to: implementation (full replication vs. sampling of index components), currency hedging and management fees/costs.

Zweig and Pilon in the WSJ’s “Is your adviser pumping up his credentials”discuss how “financial advisers are using these dubious designations as marketing tools to win the trust of older, wealthier clients, in hopes of selling high-fee investments that aren’t appropriate for them….many well-established credentials, including the certified public accountant, chartered financial analyst and certified financial planner designations, require long study, demand continuing education and enforce strict codes of ethics. Many newer credentials, however, require comparatively little effort on the part of the students…Many credentials sound confusingly similar.”

In the WSJ’s “Long-term-care premiums soar” Tergesen and Scism report “People with long-term-care insurance policies are getting hit with a new round of steep (up to 40%) premium increases. Some say that companies made bad actuarial assumptions (more people use the benefits) or expected return rates are now lower than anticipated (or perhaps fell to the temptation to suck the customer in with low rates and then increase rates later). The authors suggest ways to lower LTCI premiums by: reducing years of coverage, stop paying premiums and living with the already earned benefits, finding another vendor, and hybrid policies (e.g. annuity/LTCI, life/LTCI). (Long-term care insurance is a very complex area; I took a shot at providing some background information for readers in a couple of blogs LTCI-I Long-Term Care Insurance- An Overview and LTCI-II: A Quantitative View if you are interested in the topic.)

The Globe and Mail’s Rob Carrick in “Online money managers help you help yourself” looks at three free online tools being launched shortly for Canadian investors (aggregating  bank and investment accounts), Know your Financial Advisor (finding a suitable advisor) and (“second opinion on your investments”).

In the Financial Post’s “Can’t save money? You’re not trying hard enough” Jonathan Chevreau argues that people are not achieving their goals due to lack of discipline. “You want to save, it’s got to hurt, like exercise. If you don’t want to pay the price, then keep spending and find yourself no further ahead five years from now than you are now.” “Pay yourself first or pay yourself never.”

In the WSJ’s “To be a winning investor, know the risks” Chuck Jaffe reports that “a pair of new studies on investor behavior suggest that investors are doing what feels good, rather than what most experts believe is right.” Jaffe says that “the way to beat back risk is to accept it in different forms”: purchasing power risk (not keeping up with inflation), interest rate risk (current low reinvestment rates and locking them in for long maturity), shortfall risk (not meeting asset goals for retirement due to overly conservative or aggressive portfolio), and timing risk (buying high and selling low)…and others.

Edward Wyatt in the NYT’s “Whistle. Then worry and wait.” looks at the challenges of a whistleblower, as well as signs of a Ponzi scheme. (Thanks to Dan Braniff of CFRS for recommending article.)

Aryeh Katz looks at Bob Farrell’s “Ten timeless rules for investors” in the Globe and Mail. Among the rules are: market reversion to the mean, “there are no new eras so excesses are never permanent”, “the public buys most at the top and the least at the bottom”, “when all the experts and forecasts agree, something else is going to happen”.

Jacobsen, Chan and Bebee’s article “Balancing longevity risk and market risk in target date funds” in University of Toronto’s Rotman International Journal of Pension Management is a good education on target date funds. Their conclusion “In short: contribute early, contribute a lot, and when it comes to taking distributions, spending less will make your nest-egg last longer.” Also “A higher savings rate increases terminal wealth forecasts and tends to decrease income replacement needs in retirement, both of which increase the probability that a portfolio will last through retirement. A conservatively positioned glide path, particularly in the second half of the pre-retirement period, may help to mitigate the impact of adverse market outcomes and further decrease the probability of investors outliving their assets.” (Target date funds use an age-dependent asset allocation; while such a generic age-dependent glide-path is better than being mindlessly exposed to a very risky portfolio near or in retirement, a better approach is on based on individual risk tolerance rather than age alone…no mention of longevity insurance a missed opportunity in the article’s context) (Thanks to Ken Kivenko of the Canadian Fund Watchfor recommending the article.)

In the InvestorNews’ “Why disclosure is insufficient to ensure a fiduciary standard” Knut Rostad argues that “while disclosure helps with voting and buying choices, the process of selecting investments for a retirement portfolio is much different from voting or buying a car…evidence abounds that many retail investors are inexperienced and poorly informed — as well as subject to behavioral biases that negate the effectiveness of disclosure.” “To merely conclude that investors are “confused” about the differences between brokers and investment advisers may be to mischaracterize and understate how well many investors are engaged with their broker or adviser and the services they provide…In a healthy fiduciary relationship that involves personalized investment advice, disclosures shouldn’t be viewed as a presumptively effective investor protection tool. They are an aid to the fiduciary relationship, not a substitute for fiduciary responsibility…an investment fiduciary alone should be held accountable for his or her conduct and advice shouldn’t be controversial. After all, no one suggests that either a surgeon or an attorney be relieved of their fiduciary responsibility to put our interests first, merely by virtue of a “disclosure.” (Thank to Ken kivenko for recommending article.)

Real Estate

Doug Sword in the Herald Tribune’s “Latest shift in tax burden” discusses the last two years’ shift in property tax load in Florida from snowbirds and businesses to homesteaders. (It is difficult to have much sympathy for homesteaders who still carry a significantly less than fair share of the property tax load. This was the result of repeated property tax changes in the last two decades designed to explicitly shift the tax burden onto non-homesteaded property owners via special deals for homesteaders like: exemptions and more exemption, caps and then portability of accumulated caps associated with Save-Our-Homes amendment. It is just a shame that it takes devastating drop in property values to even start adjusting the built-in inequities suffered by non-resident owners. When will Floridians figure out that the system is totally broken and fix it? The sooner, the faster real estate prices will start recovering.)

Ron Lieber warns his NYT readers to “Avoid foreclosures market until the dust settles”, The risks associated with foreclosed properties include: banks are reluctant to provide a mortgage unless property is ready to move in, auction process is dangerous for naïve, sloppy or negligent buyer and agent, titles are in question so title insurance is a must (if you can get it on a foreclosed property) and include a rider for the cost of fix-up, and inadequate inspection to detect sabotage. Risk should decrease in a few months as “all eyes are on the foreclosure process”, and to be foreclosed homes will be done so with “more care and precision”. The Globe and Mail’s “Foreclosure crisis could ‘paralyze’ housing market” discusses how this will slow down home sales given that foreclosed home represent 30-50% of all recent sales in many areas. If you are interested in the subject of foreclosures you can also read “Bankers ignored signs of trouble on foreclosures” about how we got here, and “September home foreclosures to 100,000 for first time” about the exploding foreclosure rate.

In the Globe and Mail’s “Realtors keep grip on MLS in deal with feds” Steve Ladurantaye reports that the Canadian Real Estate Association has reached an agreement with the Competitions Bureau of Canada, which will allow private sellers to list their homes on MLS for a fee, but that real estate agents will receive pre-arranged compensation if their bring the buyer. “Sellers who pay a flat fee for a listing won’t have their contact information posted on, the public hub for MLS listings, although the listing can provide links to other sites that contain contact information.” (I guess we’ll have to wait for the ‘details’, as the implications of last quote in particular is not clear. The devil is always in the details.)


The WSJ’s E.S. Browning writes in “Pension funds flee stocks in search of less-risky bets” that pension funds dialled back on risk in the past 2-3 years from 70% equity allocation to about 45%. The reduced allocation, (while sensible from an asset-liability matching perspective) will require higher company contributions to their DB plans due to the correspondingly lower return expectations on assets. The lower equity allocation may also be affecting equity prices.

Greg Hurst in benefit Canada’s article “The best kept CAP secrets”discusses Canadian Capital Accumulation Plans from insurance companies and that they contain guaranteed minimum annuity rate basis “to minimize risk for the insurer relating to changes in the discount and mortality rates”; these rates are specified to a level that the insurance company would never expect to apply. “A common guaranteed minimum annuity rate basis at that time utilized a discount rate of 4% per annum and the group annuity mortality table for 1983….But fast forward to 2010. The guaranteed minimum annuity rate basis under a 1990’s contract will look much, much more attractive to those considering retirement now, delivering lifetime guaranteed retirement income at levels from 30% to 45% higher than current market annuity rates. Policies issued before the 1990’s will look even better!” He also discusses the impact on companies which might wish to change CAP provider and disclosure requirements to plan members.

For those who are interested in the arcane subject of pension funding and accounting, you might be interested in reading a 12 page document at the U.S. actuaries’ web site entitled “Fundamentals of current pension funding and accounting for private sector pension plans”

Things to Ponder

Ferguson and Schofield, in the Financial Times’ “Equal weighted portfolios perform better”, write that it can be proved mathematically that “equal-weighted portfolio will beat a capitalization-weighted benchmark over time, if the distribution of capital across the stocks in the benchmark is reasonable.” “Since January 1 1966 to June 30 2010 “a simulated equally weighted portfolio of S&P 500 stocks beat the capitalization-weighted S&P 500 be an average of 3% annually”! According to the article this due, not to the “small-stock effect”, but to “capturing relative volatility” which “is a consequence of the trading rule required to maintain equal weights, which is to buy after a negative relative return and to sell after a positive. To the extent that stocks move up and down relative to the cap-weighted benchmark, the trading rule has a “buy low/sell high” character, which generates outperformance.” (Very interesting, but there is no mention of much higher management, trading and tax costs incurred with an equally weighted vs. capitalization weighted portfolio. Not clear if that effect was accounted for.)

In the WSJ’s “Currency chaos: Where do we go from here?” Judy Shelton reports on a chat with 1999 Nobel Prize recipient Robert Mundell, “father of the Euro”. His bottom line on what needs to be done today is: “Pro-growth tax policies, stable exchange rates.” (This is exactly the opposite of what is being pursued in the U.S.; hopefully he is wrong, but I wouldn’t bet on it.)

John Authers in the Financial Times’ “Plot thickens in scary world of pensions”discusses the threat to government finances of “the chronic problem of tending to an increasingly elderly population”. Authers quotes studies suggesting that unless action is taken to reduce aging related future deficits “government spending rising to 60 per cent of global domestic product, from 44 per cent today. The debt burdens would be unsustainable. In the UK, government debt would rise to more than 430 per cent of GDP by 2050…” He also discusses the potential impact on stock prices.

Robert Frank in the WSJ’s “The world’s richest man: ‘Charity doesn’t solve anything’” quotes Carlos Slim, the world’s richest man, on the subject of charity/giving that instead of aiming to “leave a better country to our children…it is more important to leave better children to our country”. “His point seems to be that society would benefit more if the wealthy channelled their creative energies and talents toward building job-creating businesses rather than doling out cash.” (Obviously has a difference of opinion with Gates/Buffett.)

Gillian Tett in the Financial Times’ “Japan illustrates conundrum of deflation” reports that a recent survey of Japanese population about deflation indicated that instead of a “picture of pain, if not panic…Japanese consumers apparently feel rather differently. In last year’s survey, 44 per cent of Japanese said deflation was “favorable”, while a further 35 per cent felt neutral about the phenomenon – and just 20.7 per cent described it as “unfavorable”.” The article discusses the impact of deflation on different age groups and differences in US and Japanese demographics. (You might also be interested in reading my recent blog on Deflation: Impact on retirees? Is it necessarily bad?)

Tom Bradley the Globe and Mail article “Why volatility doesn’t always equal risk” points to what appears to be disillusionment in stocks and investing by many people after “two hair-raising bear markets and two equally impressive recoveries” in the last decade. Investors who are “drawing on their portfolio for income” (like retirees) can’t afford serious losses, but for younger investors “who have the luxury of time, volatility doesn’t equal risk, not in theory anyway. These investors can hold assets with a higher potential return knowing that short-term price swings are inconsequential. Long-term returns are what matter. Risk is holding overpriced assets, being too concentrated on one type of investment, and having no protection against inflation. Risk is having a portfolio that doesn’t fit with their objectives.” For long-term investors volatility shouldn’t be a risk factor, but it clearly is….(because) “strayed far from their long-term asset mix…holding too much cash…are likely to delay doing any rebalancing”. (You might also be interested in reading my related Time Diversification: Stocks less risky over the long term? (Not!) blog.)

A warning! The Economist’s Buttonwood writes in “The magic bullet”that QE is today’s mechanism for competitive devaluation, and the prospect of more QE is what’s driving stock, gold and bonds all up at the same time; but it’s unlikely that this behaviour will last. “Mr Joshi says the four previous periods of triple strength since 1980 were all followed by falls in Treasury-bond prices… Some might think that shares, thanks to their links with the real economy, would do well in inflationary times. But that is not what the data show… When gold was up by more than 20% over a five-year period, the median return from large-cap American stocks in the same era was just 2.1%. And when gold fell by more than 20%, the median large-cap return was 99%.” And Buttonwood concludes with “Competitive devaluation is an inherently unstable system. Someone must lose their share of world trade. And a policy of boosting exports can all too easily turn into a policy of blocking imports.”

And finally, Gina Kolata in the NYT’s “Taking early retirement may retire memory, too” writes about a new study suggesting “that the earlier people retire, the more quickly their memories decline“. The article has an interesting graph of the country by country cognitive test scores of men and women in their early 60s plotted against the percentage of that age group retired in each country. (Hmmm…perhaps I should go back to work J !?!…Thanks to SI for suggesting the article.)


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