Hot Off the Web- June 20, 2011

Personal Finance and Investments

In Barron’s “Best annuities”Karen Hube discusses (U.S.) annuity options, including immediate fixed payouts for life, immediate payout are term certain (e.g. guaranteed for 10 years, even if you die before), deferred fixed annuities with five year guarantee (i.e. annuity starts in the future with a guaranteed rate for 5  years), capped S&P 500 indexed annuities (with built-in downside protection), and deferred variable annuities. (The latter two typically with high fees which negate any potential benefits of the equity components). Annuities are intended to provide longevity protection (needed since the probability that at least one of a 65 year old couple will live to age 95 is 25%), enhanced returns compared to CDs or other high quality fixed income sources due to mortality credits, downside income protection when equity linked or variable annuities chosen (though quite expensive). One advisor suggests the use a combination of immediate and deferred fixed annuities (sounds like an interesting approach which could be used to mitigate the otherwise corrosive effect of inflation in case of immediate fixed annuities should one live well past 85).

In the Globe and Mail’s “Fees: A new way to slice the pie” Rob Carrick looks at the growing trend of fee-only (rather than commission based) model for financial advice. However he warns that fees quoted are just list prices and you can negotiate a lower fee, “fees vary from adviser to adviser”, and “fee-based accounts could cost you more than a commission based account” (What nobody seems to discuss is “what you get for the fee?” or what constitutes advice (e.g. if you don’t have a Investment Policy Statement you probably don’t have the advice that you need) and what is the value of the ‘advice’ you are or might be receiving.)

In the Globe and Mail’s “Advisers cozying up to ETFs” Rob Carrick looks at the inroads made by ETFs in Canada so far, and discusses their further growth/evolution to be based on wider adoption by investment advisers (this is good) and the unnecessary proliferation of complex ETFs or just duplication well trodden ground already covered by existing ETFs (this is bad).

Burton and Bhalavatsalan in the Bloomberg’s “Fees sap mutual funds seeking hedge-fund return in commodities” report that fees associated with mutual funds trying to provide hedge fund like returns (e.g. managed futures) are the headwinds which erode much of the available returns; fees are stacked upon fees, many of them invisible to the client. (More complexity and opaqueness always leads much higher cost.)

John Heinzl in the Globe and Mail’s “Dissecting bond ETFs and waiting for a ‘Doomsday call’” explains that Yield-to-Maturity, which is the approximate return of an investor who holds the bond to maturity is approximate because it assumes that coupon payments are reinvested at the same rate, similarly YTM quoted for a bond ETFs is only approximate because, additionally, maturing bonds have to be rolled over into new bonds at TBD interest rates. Heinzl also warns that quoted YTM rates quoted for Canadian bond ETFs are returns before the deduction of MERs!

In the Financial Post’s “Standards to be set for financial planners” Jonathan Chevreau reports that “Five financial planning organizations have created a national coalition to set firm guidelines for anyone wishing to call themselves a financial planner. Despite repeated attempts in the past -notably in Ontario -to regulate who can call themselves a financial planner, it’s basically been a case of hanging out one’s shingle and declaring oneself a financial planner. There have been no requirements for qualifications or professional oversight.” (Standards for planners are long overdue, and they must include not just educational standards but an explicit requirement for fiduciary level duty toward the client. It is an encouraging step and we’ll be watching its outcome. Recommended by Ken Kivenko of Canadian Fund Watch)

In the NYT’s “Financial advice gleaned from a day in the hot seat”Paul Sullivan receives a critique of his saving and spending from a group of Tiger 21 members (net worth of >$10M each); he was expecting to pass with flying colours, but walked away bruised though wiser. The advice included: insufficient life and disability insurance, spend only what you need not what you can afford, get more liquid by selling vacation property, and in retirement they recommend spending 3% of assets to allow assets to grow.

Real Estate

In the Financial Post’s “Housing rush fuels debt, leaves many ‘vulnerable’: Carney”Tim Shufelt quotes Bank of Canada Governor Carney indication that “Canadians are now as indebted as the Americans and the British…The Bank estimates that the proportion of Canadian households that would be highly vulnerable to an adverse economic shock has risen to its highest level in a decade, despite improving economic conditions and despite the ongoing low level of interest rates.” “At a 4% real mortgage interest rate — equivalent to the average rate since 1995 — affordability falls to its worst level in 16 years. As I have observed, some markets are already severely unaffordable even at current rates.” With the exception of Vancouver where selling prices are at 11 times average household income and some, Carney “expects a soft landing for Canadian housing, explaining that, for the most part, expansion has been supported by underlying demand forces”. Other analysts add that “the risks to the economy from negative equity may be greater than ever before, particularly when that growth in debt has been driven by the already most leveraged households.”

On the same topic Garry Marr in the Financial Post’s “Vancouver red hot in our ‘Goldilocks’ housing market”reports that CREA indicated that “the average price of a home sold across the country last month was $376,817, an 8.6% jump from a year ago. Remove Vancouver from the equation and prices are up only 5.6% on a national basis…While not as hot as Vancouver, as a much larger city Toronto’s year-over-year price increase also helped skew the national number. Remove Toronto as well from the national equation — the average sale price reached $485,420 in the city in May — and prices nationally are up just 3.7% from year ago.”


In the WSJ’s Key seniors association pivots on benefits” Laura Meckler reports that the AARP “is dropping its longstanding opposition to cutting Social Security benefits, a move that could rock Washington’s debate over how to revamp the nation’s entitlement programs….The group will accept cuts, but won’t champion them, and it is particularly leery of certain concepts such as eliminating benefits for wealthier recipients. “ The AARP appears to feel that Social Security reductions are inevitable and in effect wants a seat at the table, rather than be on the outside looking in.

In the Canadian Press’s “Ottawa cancels this month’s scheduled finance meeting with the provinces” Heather Scoffield reports that “Finance Minister Jim Flaherty has cancelled this month’s federal-provincial finance ministers’ meeting…Dominating this month’s scheduled agenda were pension reform and health-care funding.” (So much for the sense of urgency that the government feels is needed to address the systemic failure of Canada’s pension system. The government is counting on the private sector to solve the retirement income crisis already hitting the oldest of the boomers and about to hit the balance of Canadian boomers. Unless something changes quickly all Canadians will suffer, not just seniors, but the rest of Canadians who will have to help to support them and at the same time suffer as a result of the coming economic slowdown associated with seniors’ drop in spending. (Thanks to Bernard Dussault leader of CFRS)

Scott Deveau in the Financial Post’s “Pensions next big issues for companies”discusses the coming battle over pensions (for those who still have them, e.g. Air Canada). The battle is over delayed retirement and reducing funding formula, but the “union is loath to give any pension concessions, in part because under the current system, if interest rates were to rise a quarter of a percentage point, Air Canada’s solvency deficit would be reduced by about $340-million, she said.”Our members are not going to make concessions, then see the plan in a surplus and all of the sudden, the company’s paying dividends to shareholders”” Companies are having increasing difficulties living with the volatility associated with DB plans as a result of twice in a decade stock market swoons of the order of 50% and historically lowest interest rates driving liabilities sky high. (The problem has been aggravated by companies taking contribution holidays, partly so during good years to show superior financial results and deliver executive bonuses, but also because existing pension legislation prevented them from contributing when plan was deemed to be overfunded.

Things to Ponder

In the Globe and Mail’s “A low-rate bear still has his growl”Brian Milner reports on views that the current artificially ultra-low interest rates may be causing more harm than good. “The benefits of low interest rates are not huge and obvious. The cost of low rates may be higher than we think, including costs to savers who are getting rock-bottom interest rates and are scrambling to find higher rates, perhaps by taking on more risk. They also may be cutting back on consumption, because their incomes are not keeping up.” Other costs of low interest rates are that they also fuel high inflation in developing countries, have driven up commodity prices (which then affect developed countries), negatively impact pension liabilities, and when current low rates inevitably end this will just increase foreclosures rates for those just hanging in there due to current low mortgage rates.

In WSJ’s “China stamps out southern unrest” Jeremy page reports that riot police was brought in to control rioting in southern China by workers demanding higher wages and improved working conditions. (These are serious storm clouds on the horizon if they lead to instability in Chinese society and/or significantly higher wages adding to inflationary pressures which will then be transmitted to developed countries.)

In  “Sarkozy warns of soaring commodity prices” it is reported that “Sarkozy called Tuesday for tighter controls on the speculators he blames for soaring food and energy prices threatening global growth. “The same rules applied to curb financial market speculation needed to be used to crack down on commodities prices which threaten inflation and social tensions.” He called for more transparency in the commodity markets. Furthermore Reuters reports in the NYT’s “Analysis- High frequency trade sparks commodity flash fires” that application of high-frequency trading techniques that caused the May 2010 flash crash in the financial markets are now migrating to commodity markets and that HFTs are causing sudden and unexplainable commodity price (up and down) spikes which are affecting traditional traders. Still others are worried about “extreme correlation between different asset classes – equities, futures, commodities, energy and foreign exchange – a flash crash in one asset class could spill over… this could lead to an even bigger crash “ as described in Matt Nesto’s “”Splash Crash” could rock the global financial system: Security consultant” “Few people would argue against the need for regulators and exchanges to maintain an orderly marketplace or what Bates calls “better back-testing, risk firewalls and market surveillance.” However, staffing and paying for such an operation raises many questions, as does the thought of getting a government stamp of approval BEFORE you can make a trade. The risk is clear and present. The solutions, unfortunately are not.” (Regulators’ skills and technology can’t keep up with those being regulated. Thanks to VP for recommending article)

Solomon and Trindle in WSJ’s “New financial rules delayed”report that “U.S. regulators, behind schedule in finalizing key rules mandated by last year’s financial-regulatory overhaul, agreed to delay a host of new requirements scheduled to hit the $600 trillion derivatives market next month. …Derivatives are especially controversial because critics say they encouraged huge risk-taking and spread damage far and wide during the crisis…Regulators gained broad new powers to protect the financial system, including authority to regulate derivatives, impose stricter capital and supervisory requirements on financial firms and regulate consumer financial products.” (Not a good news story- the regulations are needed now.)

In the Financial Times’ “Time to study cycle turning points” Jonathan Davis  quotes Keynes as having said “Investment results largely depend on how one behaves near the top and near the bottom” (of the market cycle). Davis says that “many of the world’s most successful investors, according to the studies I have seen, owe their outperformance of the market primarily to their performance during bear markets, when two factors typically come into play. One is minimizing drawdown through anticipation of an impending crisis and the second is retaining the flexibility to take advantage of the valuation anomalies which severe market crashes invariably throw up. Both imply a willingness to hold cash in excess of normal levels during abnormal times.” He adds that market timing is not easy, but perhaps more research in to market turning points should be undertaken, as this is not much understood area. (No doubt that if this nut could be cracked, there is potential value, but it’s a tough nut to crack.)

And finally, in WSJ’s “What this country needs is a good 5% inflation” Brett Arends advocates a 5% inflation to cure what ails the U.S. right now. He writes that a 5% inflation would solve in a 3-4 years the problem with underwater mortgages, would eliminate a large portion on the national debt, and generally it would be default by stealth, but it would get the economy going just as inflation (associated with WWII preparations) ended the 1929 depression.


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