Hot Off the Web- November 21, 2011

Personal Finance and Investments

In the Financial Times’ “Indices- playing the weighting game” Steve Johnson discusses index construction and mentions that the S&P 500 equally weighted index (0.2% allocated to each of the 500 components) that has $3.9B invested in it has outperformed the capitalization weighted index with $1.3T invested in it over 1, 3, 5, 10, 20 years. He also notes the (old but) more puzzling question why people invest in a capitalization weighted bond index, whereby the debtors in greatest need (e.g. Greece, Italy, Ireland) are often least credit worthy yet they represent a relatively large proportion of the index compared to those with lesser credit needs. Still, while some believe that there is a movement afoot away from capitalization weighted indices, others argue that even if it happens it will be slow due to: liquidity issues, increases in “frictional costs of trading”, capacity constraints of non-capitalization weighted approaches, and general unfeasibility of scaling up.

Michael Nairne writes in the Financial Post’s “Hope is not a strategy”that “In this world of artificially low interest rates, the price of safety is enormous (i.e. using fixed income investments exclusively can lead to significant portfolio buying power reduction quite fast, when considering the corrosive effect of inflation, taxes and withdrawals)…On an investment front, an appropriate exposure to equities is critical. Fortunately, unlike the state of affairs a decade ago when ludicrous stock valuations offered little in the way of future returns, stock valuations are reasonable today… On an investment front, an appropriate exposure to equities is critical.”

In the Globe and Mail’s “When dividend investing doesn’t pay dividends”Tom Bradley discusses some of the potential problems with dividend driven investing: picking stocks exclusively on yield without factoring in the stock valuation and company prospects, difference between yield and earnings, high dividends as selection mechanism tends to lead to undiversified portfolio and opportunity cost when holding on to an dividend driven stock purchase even after it has become expensive.

Rob Carrick in the Globe and Mail’s “The elusive search for financial advice” discusses the (finally) growing interest in buying “financial advice straight”. “The idea of pure advice is appealing because it does away with the conflicts that can arise when an adviser is compensated through the sale of products that generate commissions and fees.” Carrick explains the difference between “fee-only” (hourly based charge) vs. “fee-based” (some percent of assets, typically 1%/year) or some combination of the two. Clients also want different things: a financial plan, a second opinion and/or ongoing portfolio management; but fee-only advisors face the challenge of making a living exclusively from ‘one-time’ financial plans. Unfortunately, clients often don’t want to pay what appears to be a very visible and high cost associated with some of these services, but are perfectly happy to pay the embedded five times as much trailers in mutual funds for similar or lesser ‘advice’ (Don’t forget that while fee-only advisors might have fewer conflicts of interest compared brokers and commissioned mutual fund salesmen, fee-only advisers are not necessarily client’s fiduciaries, especially in Canada.)

And speaking of financial advice without a fiduciary level of care, in the Globe and Mail’s “Terrible financial advice- available at a location near you” Ted Rechtshaffen discusses a case of bad financial advice provided by an advisor driven by personal greed and  given the conflict of interest in the context of his role as an ‘advisor’ selling leveraged investments in high cost insurance company segregated funds.

In the WSJ’s “Grandparents bearing checkbooks”Veronica Dagher writes that grandparents often help their grandchildren in various ways (car maintenance, toys, tuition, insurance, medical expenses, etc), but she warns that very often grandparents don’t do the necessary math to make sure that the help they provide is consistent with their ability to provide it, and they don’t jeopardize their retirement in the process. Also, helping grandparents may lead their grandchildren to make “poor debt decisions down the road and ultimately prevent them from becoming “financially healthy” adults”.

Journal of Financial Planning’s “Probability-of-failure-based decision rules to manage sequence risk in retirement” is a great article by Frank, Mitchell and Blanchet to remind practitioners that withdrawal strategies based on fixed percentage of assets at start of retirement, and then adjusted for inflation annually, neither lead to realistic retirement plans nor to realistic retirement income portfolio simulations. Approaches which regularly factor in the “current (rather than initial) context” parameters like remaining assets, asset allocation, life expectancy changes, remaining sustainable withdrawal rate based on ‘acceptable’ failure rate tend to be more ‘realistic’ in terms of actual human behaviour and lead to superior results. The authors also note that “Changing the withdrawal amount is more effective in managing retiree exposure to sequence risk than changing the portfolio allocation“. On the same topic, Kelly Greene in the WSJ’s “How much is too much” looks at various withdrawal strategies and how they might have worked out since 2000. The common thread for the more likely to succeed approaches is ‘flexibility’ and willingness to take reductions in income after market hits, and abandoning the expectation of setting some initial withdrawal rate (e.g. 4%) in place and adjusting it for inflation over the next 40 years.

In the Financial Times’ “Poor ETF decisions could be a ‘ticking time bomb’”Chris Flood writes that the use of ETFs doesn’t guarantee success. Investors could still end up with ““misshapen” portfolios unsuitable for their needs” if they don’t have proper advice and they may be better off with a single multi-asset portfolio consistent with their risk tolerance. Furthermore using synthetic ETFs or actively managed ETFs, rather than plain vanilla broad index passive physical based ETFs can lead to more problems. The argument that transparency cures all problems doesn’t hold water in case of complex products; transparency and simplicity is the answer.

In IndexUniverse’ s “The long view- building the 3-D shelter” Robert Arnott writes that “Unlike “the market,” we believe inflation will be a factor in the next decade or two because of the game-changing effects of deficits, debts, and demographics (3-Ds)… Over the past two years, we have encouraged investors to place a greater emphasis on real return asset classes and the emerging markets (where our 3-D headwind is a relative tailwind). We also advocate using an expanded inflation-protection asset class toolkit and tactical management to produce substantive real returns in such an environment.2 Key tools in the toolkit: traditional real return asset classes (TIPS, commodities, and REITs) and what we have labelled “stealth inflation fighters” such as bank loans, emerging market local currency debt, high yield bonds, and convertibles—the same assets that were brutalized in the third quarter!… Inflation is 3.9% and core inflation—inflation net of the basic things that dominate the spending of working families—is 2%. Compounding matters, inflation is calculated in a way that produces figures 2–4% lower than in the past. So, 3.9% inflation probably means 6–8%, using the old fashioned method. The difference? The old fashioned method simply asks how much prices are rising or falling. The new method asks how much quality-adjusted prices have risen or fallen… So, contrary to the prevailing current view, we are strongly inclined to believe the big issue for most investors over their relevant investment time horizonwill be the wealth-eroding effect of inflation.” Arnott recommends: Emerging Market Debt, Investment Grade Credit, Emerging Market Equities and High Yield Bonds.

In Barron’s “Reeling in the yields”Karen Hube looks at some places to explore possible investment income of 7%-plus. Investment types mentioned include: closed-end corporate bond funds (e.g. ACG, BTZ), municipal bond funds (applicable to U.S. taxpayers only), high-yield bonds (e.g. HYG), emerging market government bonds, dividend-paying stocks, REITs (e.g. CPT, AVB), immediate fixed annuities and longevity insurance. (I can’t vouch for these recommendations but in an environment where prevailing interest rates are in the 0-2% range, reaching for interest rates in the 5-7% range is not risk free.)

In the Globe and Mail’s “Want a no-cost ETF?” Preet Banerjee sings the praises of ‘no-cost’ ETFs and he specifically mentions a European one (where these constructs are very common) which is not a “plain vanilla ETF” (the type you should consider investing in) but it does track “plain vanilla benchmark”; the zero-cost is achieved by a combination of: “direct holdings”, securities lending, a “partial swap, which is a derivatives-based strategy to reduce costs”. (I wouldn’t advise anyone to build their portfolio on this type of ETFs in order to eliminate the last few basis points of ETF costs; not worth the added risk.)

Real Estate

In the WSJ SmartMoney’s “The fuzzy math of home values” Alyssa Abkowitz discusses the online estimates of home values at websites such as Zillow, and The uses of these estimates ranges from voyeurism/entertainment to helping sellers/buyer set ask/offer prices and all the way to mortgage bankers’ using them for preliminary estimates. However the estimates can routinely be 20-50% away from the eventual selling price of the home. The technology doesn’t replace the thorough analysis that a professional appraiser can provide.


The past week Canada’s federal government tabled enabling legislation for the much heralded (well, at least by the government) Pooled Retirement Pension Plan (additional legislation will be required by the provinces before PRPPs will be available.) The articles in the Financial Post and Toronto Star by Jonathan Chevreau “PRPPs: Big banks love them. Big labour not so much”, Jason Heath “PRPPs are ‘nothing more’ than an RRSP” and Moshe Milevsky “A pooled pension plan isn’t a pension, it’s tax sheltered savings plan”, pretty much get the message across: “welcomed by the big banks and insurance companies but seems somewhat of a setback for the labour movement”, “a voluntary CPP gives Canadians the security of a Defined Benefit plan” (the CPP is not really a DB plan, but it is close…), “a defined contribution or DC pension, is really nothing more than an RRSP. This is essentially what a PRPP will be”, “One should not confuse an investment plan with a pension plan. The former is just a collection of money that moves up (and down) with market-linked instruments. The latter is a guarantee, a promise, a life time of security. Canadians need more longevity insurance and old-age protection, similar to the pensions of public sector employees” and “the PRPP looks like a group RRSP with some minor legal and administrative differences”. (Unfortunately, Canada’s long-awaited pension reform is anything but that, so far. You might also be interested in reading my earlier blogs on PRPP (Pooled Retirement Pension Plan) and Pension Reform: It’s not rocket science unfortunately nothing much has changed since these blogs were written.)

Things to Ponder

In MSNBC’s “More Americans expecting to retire in their 80s”David Pitt reports that a recent survey indicated that “25 percent of the respondents said they’ll need to work until at least age 80 because they will not have enough money to retire comfortably. Even those who plan on retiring expect they may continue working in some capacity and for various reasons: About 75 percent said they expect to work in their retirement years; about 39 percent said they will need to work to afford things they want or to maintain their lifestyle; and another 35 percent say they’ll work because they want to. It seems the old expectations of working until one’s 60s and then taking it easy have been cast aside. (Thanks to MB for bringing to my attention.) In the same vein CARP reports that in Canada, “The employment rate of individuals 55-plus has grown considerably in recent years. From 1997 to 2010, it rose from 30.5% to 39.4% for men and nearly doubled for women, 15.8% to 28.6%. Whether it’s a choice made by preference or necessity, Canadians are increasingly working into older age.”

In his Financial Times article “Loosening the benchmark straightjackets” Brian Bollen discusses comments from the (index-threatened) financial industry that: just as investor objectives are increasingly(?) personalized so should be the corresponding benchmarks, “benchmarks were originally designed to help measure fund manager performance, instead they became straightjackets for the industry”, there is no future for traditional benchmarks, traditional index investing used to be sub-optimal but now it is dangerous (?). Other (less conflicted and threatened) investment managers believe that while there may be a place for customized benchmarks and that traditional indexes may have flaws, the traditional indexes are here to stay. (Do you get a sense that given the massive shift under way to an indexed approach to portfolio implementation many active and high cost investment managers feel threatened and they are rolling out the old FUD (Fear, Uncertainty and Doubt) to sow confusion in investors’ minds? Perhaps Churchill’s comment about Democracy is also applicable to traditional indexing; it’s the worse system around…except for all the others.) There are a couple of other index related articles in the Financial Times in the last few days that you might find interesting. One is “Index providers tweak rules as investors raise concerns” where the differences between “rule-based” vs. “committee-based” index approaches are discussed and “Could some passive asset owners be more active?”in which the impact of less activist approach used by index-based investors might also extend to less activism in corporate governance matters as well.

In the Financial Times’  “That’s 1,000 olives, please”Gillian Tett looks at history to gauge how the disintegration if a fiat currency might unfold and concludes, based on her personal post-USSR experience, as “that old rouble note on my desk is a potent warning that sometimes the tectonic plates of the political economy can shift with stunning speed – even when politicians insist they cannot.”

And finally, here is a two minute video clip of Phil Donahue interviewing Milton Friedman on the subject of Capitalism, 31 years ago. (Thanks to SR and IM for bring to my attention.)


Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: