Hot Off the Web- March 21, 2011

Personal Finance and Investments

In the WSJ’s “A smarter way to buy insurance” Daisy Maxey writes that “Most people who buy life insurance do so from an agent working for a life-insurance company, or from a broker who receives a commission. But a lot of financial advisers are suggesting a different approach for their clients: Find a fee-only life-insurance consultant.”  Maxey says that while an agent or broker is not legally required to act in a fiduciary role. “Fee-only insurance consultants are more likely to offer unbiased advice on which life-insurance policy is best for the client” and they may be able to improve a recently purchased policy or to assess options (perhaps even restructure an existing policy)  when an insured is contemplating cancelling an existing policy”

In the Globe and Mail’s “Doing some dividend detective work”Rob Carrick looks at Canadian banks’ dividend history, yield, growth rate, and payout-ratio as a means of explaining to his readers how one might go about evaluating dividend paying stocks in general. (You might also want to be careful not to become very concentrated in a few sectors just because of high dividends.)

Real Estate

(Looks like a slow week for real estate.)

Pensions

In the Globe and Mail’s “Quebec budget revamps pensions to create plan for all workers” Rheal Seguin reports that Quebec announced increased QPP contributions (payroll taxes to employers) and a PRPP-like Voluntary Retirement Savings Plan (VRSP). But the devil, as usual, is in the details. The QPP contributions are increasing from 9.9% to 10.8% and the penalties for starting QPP before age 65 increase (as do the inducements to start QPP later than 65). The details of the VRSP remain to be determined but the document at least appears to recognize the importance of a low cost structure; time will tell if they can influence industry keep fees low (my definition <0.5% all-in costs). Quebec is also hoping that the Federal government will introduces in this week’s budget the necessary tax changes to permit VRSP to be treated just like RRSP where tax on contributions is deferred until moneys is withdrawn from the plan. The QPP changes confirm that it is not really a DB plan but a target-benefit plan (just like CPP for which contributions were changed in the 90s…furthermore these plans may not be as low-cost as previously suggested or as many 401(k) plans in the U.S. have achieved…which might partially explain why contribution rates have to increase…though stated reason was demographic differences between Quebec and Canada) (Thanks to CARP’s Susan Eng for recommending article)

Greg Hurst in Benefits Canada’s “A case for allowing pension funds to manage PRPPs” encourages allowing OMERS and other large Canadian pension plans to be permitted to compete with financial institutions, in the hope that competition will drive fees lower. “Utilizing OMERS new voluntary contribution account fees as an example, fund investment management fees could be as low as 0.50% per annum (and possibly less), along with a fixed administration fee of $23 per member account.” (That’s quite interesting, as my hurdle rate for a credible program is for all-in costs to be <0.5%/year, and they are getting close. Not clear in the article if this OMERS voluntary contribution plan is referring to only incremental contributions for those already covered by an OMERS plan or this is available to unaffiliated individuals?) He also points out that any Canadian can already join the SPP (Saskatchewan Pension Plan).

In a sign of things to come the Economist’s “Running faster but falling behind” the latest OECD study indicates that pension age is (inevitably) creeping up despite the often violent protests associated with it. “Despite the agonies of reform, the increases in pension age have not gone far enough. And, once they have been put up to a level that makes pension systems sustainable, they should be linked to life expectancy, so that from that point they rise automatically.” (Recommended by the CFAInstitute’s Financial Newsbriefs)

In the Financial Times’ “DC pension savers head for poverty”Ruth Sullivan writes that “In Britain, people in such schemes have lost an average £10,000 a year of future retirement income over the past decade and will need to save a third of their salary to make up the shortfall…” A combination of “low contributions, weak equity market performance and declining annuity rates” are the root cause of the decline and DC plan members are advised to “regularly review their expected retirement income”. (This is essential, and it should be part of the required information provided by DC plan administrators to help plan members adjust their future contributions/saving as well as their retirement lifestyle expectations. Open-loop DC plans can lead to poverty.) One expert quoted in the conclusion said that “finding a coherent strategy for a viable public and private pension system was essential to “deal with the vacuum left by the decline of defined benefit schemes in the private sector which, if left unattended, would probably have to be filled by the government eventually”.

Martin Woolf in the Financial Times’ “Pension reform makes sense up to a point”comments on recent recommendations for reform of the UK public sector pension system by changing final salary  with career average schemes and capping the cost of public pensions. Mr. Wolf however says that while this would be an improvement, these changes would still leave some anomalies unresolved: (1) “the discrepancy between the pension position of private and public employees would be cemented”, (2) “public employees are substantially more generously remunerated than equivalent private employees, with pensions taken into account”, and (3) “the huge discrepancy in pension treatment of public and private employees must make it more difficult to move people from the public sector”.

In Benefits Canada’s “Will PRPPs succeed?”Fred Vittese says that for the PRPP “Success can be measured in two ways: by improving coverage and by lowering asset management costs, which should lead to higher payouts for the same level of contributions.” He spends the rest of the article explaining why 100% participation is not the goal (for many RPP, RSSP and TFSA are better), and why low-fees will not be achieved if left to market forces. He concludes with “PRPPs might fail to improve coverage or lower management fees, depending on how they are rolled out. If they fail in these two critical ways, it won’t be long before we decide we should really have expanded the C/QPP after all.”

Things to Ponder

In the Financial Post’s “111 years of lessons”Michael Nairne suggests long-term focus for investment plans, and incorporating historical lessons. He quotes from a recent study indicating that over the past 111 years global (19 countries) stocks had annual real returns of 5.5% while bonds 1.6%, which implies that some equity exposure is required for most. The overall global return beat 2/3 of the 19 countries in the survey, and its volatility was 25% lower than the individual country average. He also warns readers that investors to keep in mind the losses suffered by bonds in real terms “in the U.S. after World War I, the real value of bonds declined by 51% over five years” and “from 1940 through 1981, bonds suffered a staggering 67% reduction in real value”. “An equally weighted portfolio of these two assets (stocks and bonds) in the U.S. had a real annual return of 4.5%, nearly three-quarters of that achieved by stocks alone but with only one-half the volatility. “

The Financial Times’ Lex article “Catastrophe and power of panic”  points to the difficulty of assessing the outcomes of low-probability events. “But each calamity, however unlikely, poses insoluble problems for investors. Refusing to go with an irrational flow hurts performance for a while, and could prove durably stupid if the terrible actually happens. And even accurate knowledge of small probabilities cannot really help investors. If the, say, 0.05 per cent chance of a nuclear mega-disaster turns into reality, the right portfolio is the panic one. A more normal selection would hardly be helped by a probability-weighted hedge. But if the 99.95 chance proves right, high-minded resistance to fear is, in the long term, correct.”

In the Globe and Mail’s “Soaring commodity prices at mercy of demand- from speculators” Brian Milner quotes commodity trader Lawson with 30 years of commodity experience that “Supply and demand establishes the balance sheet. But when participants come in with amounts of money that are multiples of the available commodity, that’s speculation. We always say that the specs got more money than the trade has cotton…when these guys come into the market, they’re not doing it on a demand-supply basis. They’re looking for somewhere to place money. They’re looking for an investment that gives them alpha, some kind of yield that can improve their returns. They’re the whale that jumps into the pond.” “But one of the things I learned a long time ago is that speculating in futures is God’s way of telling you you’ve got too much money.” But Steve Johnson writes in the Financial Times that “CTAs: ‘true diversifiers’ with returns to boot”, CTAs’ (Commodity Trading Advisers) “contrarian performance of managed futures funds – predominantly computer-driven, systematic trend-following vehicles – during downturns seems to be baked into markets’ DNA’”. “They are a true diversifier that over time produce an attractive risk-adjusted return.”  “They found the BarclayHedge BTOP 50, an index of managed futures funds, made positive returns in 12 of these periods, including double-digit returns in the quarters encompassing Black Monday, Iraq’s invasion of Kuwait, the Long-Term Capital Management crisis and the bursting of the dotcom bubble. Of the three negative quarters, the worst was a loss of 3.7 per cent.”

In the Financial Times’ “Why investors in Europe need a John Bogle”Pauline Skypala, while looking at Morningstar’s Second Global Investor Experience Study covering 22 countries, discusses the frustrations of European fund managers with high distribution costs by intermediaries who have a stranglehold on end customers. “This makes portfolio managers tremendously angry because all those extra basis points we are paying for distribution they need to generate in extra alpha” and “The high charges are a big contributory factor to the failure of many active fund managers to outperform.” The U.S. fund industry generally scores well because of the “Vanguard factor” and John Bogle advocacy for low cost investing. By the way Skypala concludes with “Canada, by the way, is the only market to score an F for fee levels. The average asset weighted expense ratio for equity funds there is 2.4 per cent”. (So investors in Canada need a John Bogle even more!)

Vince Heaney looks at pros and cons of including gold in a pension fund in the Financial Times’ “Gold’s role in pension funds under scrutiny”. He suggests that given that “In practice gold shares characteristics with both monetary assets and the underlying supply and demand trends arising from its industrial and jewellery use”, central banks’ recent reversal of decades long gold sales to become net purchasers, rising Asian retail demand with increasing prosperity, coupled with various quantitative easing programs and accompanying fears of inflation, might make gold a justifiable pension asset even though its lack of cash flow makes it unusable as hedge for long=term pension liabilities.

In WSJ’s “New efforts to simplify end-of-life care wishes” Laura Landro reports on a new program complementary to ‘advanced directives’/‘living wills’ (which allow people to specify their desired end-of-life care) is available in many states called Physician Orders for Life-Sustaining Treatment (Polst). “A Polst, which is signed by both the patient and the doctor, spells out such choices as whether a patient wants to be on a mechanical breathing machine or feeding tube and receive antibiotics. Polst programs are currently in use in 14 states and regions, including California, Oregon and New York. Three states, Colorado, Idaho and Pennsylvania, adopted Polst programs recently, and another 16 states and six regions are developing programs. Besides providing documents that meet local regulations, the programs train health-care providers to discuss end-of-life treatment choices with patients with terminal illness or anyone wishing to define their care preferences.”

And finally, in WSJ’s “Is happiness overrated?” Shirley Wang reports that “Some researchers say happiness as people usually think of it—the experience of pleasure or positive feelings—is far less important to physical health than the type of well-being that comes from engaging in meaningful activity.” “Eudaimonic well-being” (the state resulting from engaging in meaningful activity- “raising children, volunteering, going to medical school”) is much more conducive of remaining cognitively intact while aging than “hedonic well-being” (the state resulting from pursuing activities intended to achieve happiness- “a good meal, an entertaining movie”). “Sometimes things that really matter most are not conducive to short-term happiness,” says Carol Ryff, a professor and director of the Institute on Aging at the University of Wisconsin, Madison.