Hot Off the Web- September 19, 2011

Personal Finance and Investments

Preet Banerjee writes in the Globe and Mail’sNot all the arrows are pointing down” writes that as correlations increase dramatically in market swoons people question the value of diversification. He reminds readers however that while it is true that just about every stock index is down for the year, a properly diversified portfolio includes the appropriate bond allocation which has done very well YTD. “A simple 50/50 mix of exchange-traded funds tracking the TSX Capped Composite Index (XIC) and the DEX Universe Bond Index (XBB) would still be in positive territory from the beginning of the year until the end of August… Just as stocks will not always beat bonds, correlations will not always be low. That’s been the normal for a long time.”

In the Financial Post’s “Canadians are hooked on cheap money”Jonathan Chevreau writes that “Make hay while the sun shines: the time to cut debt is while you’re still working and interest rates are low. It’s easier to reduce mortgage principal when rates are low and more of your payments are going to principal, rather than interest. If you’re considering buying a home, don’t view low rates as an opportunity to get “more” house. View it as a chance to get a modest home you can own free and clear as soon as possible. If and when interest rates do rise, you want to be on the receiving end of payments (as a bond holder), not on the dishing-it out end.”

In the Globe and Mail’s “Freedom 55 and other retirement myths”  Roma Luciw quotes the author of a new book on retirement planning that the following are myths: 75% pre-retirement income replacement, debt is bad, freedom is the objective, diligence and planning guarantee good retirement, stocks must be part of retirement portfolio. (To suggest that these are myths, and you can violate these with impunity, rather than exception, is to mislead people into complacency.)

In WSJ SmartMoney’s “Income for life, guaranteed (Sort of)” Kapadia and O’Brien discuss the struggles of today’s retirees many of whom have lost confidence in the in the market and now “alarmed investors are finding that “guaranteed” payouts offer only penny-ante 1 and 2 percent returns — or involve unpalatable risks”. Suggested alternatives to consider include: bond ladders, delay taking Social Security until 70, annuitizing in stages, buying pure longevity insurance, managed payout funds, and others.

In the Globe and Mail’s “How you can give a boost to your spouse’s inheritance” Tim Cestnick looks at a strategy to reduce taxes upon death of one spouse with underwater taxable assets and an RRSP. Specifically he suggests naming your estate as the beneficiary of your RRSP, then “it’s possible for your executor to trigger some income in your hands in your year of death by causing some of the RRSP to be taxable to you. It would then be possible to use your unrealized capital losses to offset that RRSP income in your year of death. You see, our tax law will allow you to apply your capital losses against any type of income, not just capital gains, in your year of death (with some exceptions)… Naming your estate as beneficiary of your RRSP can make sense when you have significant unrealized capital losses to use up, particularly when you expect to have insufficient other income in your year of death to use up those losses.” He indicates that this won’t work with a RRIF since there the withdrawal is all or nothing. (You better discuss with your tax accountant if you are considering similarly complex manoeuvres.)

In Benefits Canada’s “Pension investing using ETFs”Mark Yamada describes a volatility driven hypothetical portfolio where asset allocation is determined by the value of the S&P 500 implied volatility index (VIX).  If VIX<20 then 100% stocks, if 20< VIX < 30 then 50/50 stock/bonds, and if VIX>30 then 100% bonds.  “We believe wider asset allocation shifts than those many investors have become accustomed to are the future of investing in volatile markets.” Target date funds are flawed with their predefined (volatility independent) glide-paths. He argues that reducing risk simply according to the age of the individual, is insufficient, and environment (volatility) must be factored in to maintain “consistent risk”. “This approach is theoretically better than anything available today for DC plan investors.” (An interesting idea for a tax-deferred portfolio, but likely requires professional assistance to attempt; unlike to work on large scale.)

Real Estate

The Palm Beach Post’s Kimberly Miller reports that foreclosures increased 13% in Palm Beach County, 10% Florida-wide and 33% nationally; and experts warned that this just the “trickle before the flood… But unlike previous reports that found increases and decreases in foreclosure activity were similar nationwide, there was a marked difference in August between judicial states, where a judge is required to sign off on a home repossession, and non-judicial states… Foreclosures were suspended last fall following questions about the validity of court documents used to take back homes” in  “Foreclosures ramp up: (PB)County’s 13% jump the trickle before the dam breaks, experts warn” . Also Nick Timiraos in WSJ’s “Default filings jumped in August by 33%”  adds thatforeclosure processes that have been running at much slower speeds since “robo-signing” problems were first discovered nearly one year ago…(but) The slowdown in processing foreclosures offers a mixed bag for the economy. On the one hand, banks have had fewer distressed properties to take back and resell, providing a potential reprieve to housing markets. But that could also extend the time it takes for the housing market to recover if those homes are ultimately listed for sale.”

John Nugent, one of my Florida neighbourhood real estate agents produces a monthly sold/for-sale list for our area. Using the limited sample (10) of condos that appear to have been sold in the past 30 days out of 3000-4000 available in the area, the data suggests that older (25-35 years old) 1000-1600SF units sold for between $200-260/SF while previously unsold brand new 3000-6000SF units sold for between $300-423/SF typically; these prices are >50% lower than at the peak five years ago. Furthermore, my preliminary property tax notice suggests a 12% drop in property tax this year-end a 14% drop in valuation by the PBC property appraiser (i.e. tax rates are up about 2%). The prices appear to be within 15-20% or so of the 2000 price levels, but property taxes for non-homesteaded out-of-staters are almost twice as high as in 2000.


Ellen Schultz in the WSJ’s “Who killed private pensions? concludes that “companies helped hasten the end of retirement plans and benefits”. The unexpected risk to employees’ retirement turned out to be their employer (the management of their company who juiced the earnings to increase their bonuses/pensions on the backs of employees by manipulating the pension plans. You’d think this is at least immoral, if not illegal, but it is/was common practice; to reduce/eliminate already earned benefits.) But companies claim that “they are the victims of a “perfect storm” of unforeseen forces: an aging work force, market turmoil, adverse interest rates. Certainly, these all contributed to the retirement crisis. But employers have played a big and hidden role in the death spiral of pensions and retiree benefits as well.” Some of the mechanisms used by company management to tap pension plans include: use “pension plan assets to finance retirement incentives for managers”, pay promised health benefits using pension plan assets, in mergers/acquisitions “monetized” billions of pension assets by selling pension plan assets at 70 cents per dollar when transferring employees to another entity thus leaving a less funded plan, “retiree plans have become cookie jars of potential earning enhancements” by using aggressive accounting/actuarial assumptions like discount rates and estimated returns and ultimately outright cutting benefits by converting from DB plans to DC plans or offering less than actuarially fair lump sum payouts to those leaving the company. But the drive to reduce employee benefits really took off when executive compensation was tied to company performance, fattening the payouts of the few on the backs of the rest of the employees. (You might also be interested in my “Systemic failure” rant where I discuss how corporate management was aided and abetted by professionals (accountants, actuaries, investment managers, custodians, etc) with personal conflicts of interest and governments with inadequate regulations/regulators, to steal pensioners’ deferred wages. Solutions are discussed in the Financial Post’ William Hanley interview with me “Pension crisis”)

In the Financial Times, Jerome Booth discusses the “Five stages of grief for global markets”. No doubt Nortel pensioners (and employees) can resonate with these phases of grieving, especially after the repeated blows like the market/Nortel stock collapse in 2001, market collapse of 2008 followed by bankruptcy with the corresponding Canadian pension reductions to 59% (Ontarian pensioners whose pension were $12K/year and under are effectively protected by PBGF), their already discontinued life and health insurance plan is claimed to be 34% funded. Still, many are still standing (even if staggering under the repeated blows), but others are already down for the count.

Things to Ponder

The Economist’s Buttonwood discusses p/e ratios and S&P 500 valuation in “Defending Shiller (again)”. “If you read the strategy notes put out by investment banks, you don’t see much mention of the cyclically-adjusted price-earnings ratio, a measure devised by Ben Graham and David Dodd but now associated with Professor Robert Shiller of Yale. That is because they make the US market look expensive (Europe is a different matter). Instead you hear a lot more about the prospective p/e which, based on robust forecasts for next year’s profits, make the market look cheap… People may not like what the Shiller p/e shows. But it highlighted the four great market peaks of the 20th century; that is too good a record to ignore.” Coincidentally in the WSJ’s “Peeling back the market’s P/E” Jack Hough looks at definition of various P/E measures and corresponding divergent valuations of the S&P 500: 14.5 trailing earnings, 13.5 operating earnings, 10.9 earnings forecast, Shiller’s CAPE (Cyclically Adjusted PE) 20.9. (That’s quite a range, so you’ll want to pay attention to which p/e is being quoted.)

Peter Thal Larsen in the Globe and Mail’s “UBS scandal undermines investment bank model” opines that “getting out of investment banking is easier said than done. It’s hard to see regulators encouraging another lender to take over UBS’s business. Closing the unit, and winding down legacy positions, would involve huge costs – and more risks. But UBS’s rivals should resist the temptation to gloat. For the second time in four years, a single trader has racked up a multibillion-dollar loss before being caught. The argument that banks are best off when they combine investment and retail businesses just became harder to defend.” Also, in the Financial Times Lex’s “Delta skelter: the trouble with ETFs”“The explosive growth of synthetic ETFs…is increasingly worrying regulators because the assets that support the funds are often opaque… These activities are some of the most profitable equity derivatives lines in investment banking. Small wonder such desks are among the few to still be hiring. But it is obvious that banks do not fully understand what they are doing. Regulators need to step in before the latest attempt by banks to chase lucrative but poorly understood growth areas results in a repeat of the structured products crisis from which the investment banks have yet to recover.”

In the Financial Times’ “This $2B mess has uncanny historical echoes” Gillian Tett writes that “when regulators eventually unpick this $2bn mess, I would hazard that one culprit will turn out to be a pernicious cocktail of opacity, complexity and naive enthusiasm for innovation… Consider the parallels. On paper, ETFs (just like CDOs) look like a wonderful idea; they are vehicles that enable investors to gain exposure easily to a diverse range of different asset classes, without having to pay the ridiculously high fees demanded by the active fund management industry – or engage in stock picking, say, on their own… growth has come at a cost. Although the first generation of ETFs were very stodgy – composed of cash equities, say – more recently banks have started creating more exotic structures to boost returns. In Europe, for example, so-called “synthetic” ETFs, or packages of derivatives, have become very hot and now account for almost half of all ETFs… “the dual role of some banks as ETF provider and derivative counterparty” creates dangerously close ties… in its basic (vanilla) form, the ETF idea is a sensible one and very useful for investors. But if the sector is to flourish again, it needs to go back to its roots, and become more simple and transparent. (Amen…thankfully in US and Canada ‘synthetics’ represent a much smaller percent of the overall ETFs. We seem to forget time and time again that financial/investment products are just like packaged food products, the more processed/packaged they are the less nutritional value they deliver.)

In the Financial Times’ “Beware a Hegelian touch of regulatory hubris” Gillian Tett writes that financial market regulation seems to be following Hegel’s “idea that history proceeds with pendulum swings”. After three decades ruled by “free market ideologies”, now the pendulum has swung to where bankers lost their god-like status and the belief that they alone should handle finance. Instead, a move is afoot that bureaucrats/regulators have more legitimacy in the eyes of the public. Tett warns that “an age of bureaucrat hubris creates new risks. History is littered with examples where officials have tried to control financial flows and set prices, with disastrous results. It would be foolish to expect bureaucrats to be any less fallible today, given that finance is doubly complex and bureaucrats (like bankers) have warped incentives.” (But, not so fast, “bureaucrat hubris” might not be the problem…we might be stuck with “banker hubris”…see the following story…)

In InvestmentNews’ “Freaky Thursday? Shapiro gives nod to adviser SRO, top Republican endorses more SEC funding”Mark Schoeff writes that “Securities and Exchange Commission Chairman Mary Schapiro voiced support for a self-regulatory organization (SRO) to oversee investment advisers. Meanwhile, a leading Republican expressed support for increasing the SEC budget…“Unless there is sufficient funding for the SEC to do this, I think we ought to look very seriously at an SRO, whether it’s Finra or not… We need to have better oversight” of advisers… (furthermore) Skeptics of a universal fiduciary duty rule for retail investment advice assert that the SEC did an insufficient economic analysis of the issue in a study it delivered to Congress in January. The Dodd-Frank law gives the agency the authority to proceed with such a rule.” (It sounds like the US political system’s ”checks and balances” and the old “golden rule” (he who has the gold rules) are used to gradually erode/kill the moves to improve oversight over advisers by withholding funding necessary for the SEC to do the job even though, while “the agency’s budget is set by Congress, it is funded by fees it charges regulated entities”. I suspect that the SEC might end up having to apply its limited resources to oversee the SRO that in turn takes charge of overseeing the advisers, rather than overseeing the advisers directly.) (Recommended by the CFA Institute’s NewsBriefs)

You can read about some of the effects of the rising expectations/aspirations in the east in David Pilling’s Financial Times article “When the Singapore sling meets the Arab Spring” and the west’s stagnation of incomes in the Economist’s “The real incomes of America’s richest and poorest households”. (Yet it seems the result of both has been a conservative backlash in both the east and the west. Time will tell how this will unfold.)

And finally, in the Financial Times’ “Conflict of interest in free news” John Gapper writes that “More to the point, what did anyone expect in a world where what would once have been a subscription newsletter became a free blog that relied on low-yield advertising? If publishers cannot make money in legitimate ways, someone will invent a dubious way instead.” This will no doubt lead to conflicts of interest. But “traditional news outlets have their own conflicts – even if they formally separate their commercial and editorial operations, reporters face the temptation to trade favorable coverage for inside access. But individual misbehavior is one thing; a fully-fledged business model is another… The truth is that, no matter how loudly people protest that they have safeguards in place and will not abuse their power, conflicts of interest lead to abuses as surely as rivers flow to the sea. Even if they are disclosed in disclaimers, as banks now do with investment research, bad things will happen.”


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