Hot Off the Web- September 26, 2011

Personal Finance and Investments

In the WSJ’s “Do ‘alternative’ funds deliver?” Anne Tergesen reports that ‘alternative’ mutual funds attracted significant inflow of individual investor dollars, but calls their performance disappointing. ‘Alternatives’ are supposedly designed to outperform in times of high volatility using a mix of: long/short, hedging, derivatives, and futures strategies or just reducing exposure to stocks. Their objective is not necessarily to outperform, but perform with much lower volatility; but expenses tend to erode whatever advantage they can achieve. In the Financial Times’ “Are hedge funds the answer on pension savings?” Dan McCrum reports that even as more pension funds are piling into hedge funds many are questioning the wisdom of it, due to a combination of very large dispersion of hedge funds’ performance and difficulty to both identify and access the top 100 (out of 7400) best-of-breed funds responsible for 90% of gains. On the average downside protection during the 2008 crash was no better than a 60% stock and 40% bond portfolio, and over longer period of time hedge fund performance was comparable to government bonds (with any excess performance was eaten up by fees).

In All Things Digital’s “Silicon Valley vets aim to bring personal financial services to the masses”Tricia Duryee reports that “Personal Capital’s CEO, Bill Harris, who headed up Intuit and PayPal previously, is unveiling his latest company today, which melds technology with financial advisory services…managing money to the masses, by replacing fancy offices and golf club memberships with software and video chatting…All of these tools are free, but users will have to pay for the advice — if they should want it.” (Recommended by MB)

In the Financial Post’s “Annuities deserve some attention from retirees” Jonathan Chevreau thinks annuities should get more respect than they do. He quotes Moshe Milevsky that “Basically, they (investors) think they can do better elsewhere. They also have extremely unrealistic assumptions about what their lump sum can generate in income and the investment returns they can earn on their portfolio without taking excessive risk.” Chevreau also discusses how the decision to annuitize is influenced by behavioural finance factors like “myopic extrapolation” and “framing”, as well as by financial institutions/advisors due to the fees charged and whether they can sell annuities or not. He concludes with comments on mitigating currently very low interest rates by delaying annuitization until 70 or 75, and annuitizing in stages. (Annuitization may be the right answer for some retirees, but not all. You might be interested in reading my blogs on the annuities at Annuity I, Annuity II, Annuity III, Annuity IV)

Phil Davis in the Financial Times’ “Hedge funds play with market turbulence” suggests that volatility instruments (e.g. VIX) may be productive in portfolio risk management by buying volatility to hedge market exposure. But the hedging comes at a price and their overuse (too much and/or for too long) can be a significant drag on performance. And John Dizard in  makes the insightful observation that efficient markets might not be so efficient recently, given the high volatility in ““Europhobic investors confuse noise for news”The day-to-day volatility of European asset prices tells us there is a lot of valuation error on offer. The real world prospects for national economies, and companies, don’t change that quickly.”

S&P introduced a Target-Date Indexto help DC plan sponsors do their required due diligence. Target-Date funds are a significant and growing component of U.S. DC pension plans (401(k)s). These funds follow an age-dependent asset allocation (glide-path) intended to reduce risk as one approaches retirement or even after retirement, but there are large differences between these funds: the level of risk they take at each age, the asset classes they use, their cost and implementation. To help with selection and monitoring of Target-Date funds, S&P introduced a benchmark glide-path derived from annual survey of such funds. In a Pro-Manage interview with S&P’s Phil Murphy indicated that “sponsors should look beyond simple performance comparisons. Unlike comparing a single asset class mandate against an appropriate index, multi-asset class mandates require a more nuanced approach in which an appropriate benchmark becomes an important tool”.  Asset classes in the current benchmark include: small/medium/large domestic equities, foreign developed and emerging market equities, REITs, fixed income (diversified, short-term government, TIPS, high-yield) and commodities.

Real Estate

In the WSJ’s “Home forecast call for pain” Nick Timiraos reports that “Economists, builders and mortgage analysts are predicting the weakened U.S. economy will depress housing prices for years, restraining consumer spending, pushing more homeowners into foreclosure and clouding prospects for a sustained recovery. Home prices are expected to drop 2.5% this year and rise just 1.1% annually through 2015, according to a recent survey of more than 100 economists …” (finally a positive indicator for house prices; economists forecast more pain!)


Another nail in Nortel’s Canadian pensioners’ coffin is described in Bert Hill’s Ottawa Citizen article “Last of Nortel’s brass leaves behind a 1.22 million bill”. He reports thatNortel has decided to settle obligations on a regional basis among the big interests in the U.S, Europe and Canada. This will hurt because Nortel Canada has relatively little cash or assets but significant liabilities. One of the biggest is a $2.1-billion charge against Canadian assets by U.S. tax authorities in connection with the big accounting scandal that helped bring Nortel down.” (Settling regionally is the final nail in Canadian pensioners’ coffin. It started with no BIA priority to pension plan underfunding and no DB pension insurance in Canada, and finishing of limiting movement of assets across boundaries. It looks like my worst pension settlement fears have come true, while the Canadian government and courts stood by watching.) Yet according to Peg Brickley in WSJ’s “WaMu Plan ruling puts distressed investors on notice” “Investors in the debt of the defunct telecommunications company (Nortel) are hoping to deal their way into a better-than-100% recovery. How much better may depend on whether Nortel gives the bondholders a contract rate of interest or the federal judgment rate, which is usually much smaller. What the bondholders don’t get could go to folks like Nortel’s retirees and disabled workers, many of whom are being left empty handed. Signs from Walrath that the bankruptcy judge should go with what’s fair and equitable when it comes to interest rates could push a finding in favor of the ex-employees.” (So Nortel’s bondholders might ‘only’ get 100% on their dollar with a small additional interest!  That is truly upsetting?)

It is not news, but it is worth retelling. In the Financial Times’ “Millions pay ‘extraordinary’ pension fees” Cumbo and Moore report that “some (are) losing more than a third of their savings in providers’ fees and advisers’ commissions”.

In reference to my mention in last week’s blog (September 19, 2011 Hot Off the Web) of Ellen Schultz’s WSJ article (by the way, I did not mention her new book reviewed in the NYT’s “When retirees are shortchanged”, entitled “Retirement Heist: How Companies Plunder and Profit From the Nest Eggs of American Workers”) in which she focuses specifically on the misdeeds of corporate management who often eviscerated pensions to increase profits, by reducing benefits explicitly (legal) or by taking advantage of the opacity of DB pensions to reduce contributions and other acts (that are or should be illegal) and therefore jeopardize the funded status of DB plans, reader ET suggested that in Canada perhaps government is to blame as they are the (failed) regulators of pension plans. While I am not prepared to let corporations off the hook, there is plenty of blame to go around, and not just to governments (federal and provincial). Pension plan failures (e.g. Nortel’s) could not have been done without the active participation/assistance or at least the silent collusion of some/all the conflicted professionals living off the pension industry: actuaries, investment managers, custodians, etc. Government’s inaction and flawed actions was particularly damaging in Canada where private sector DB plan beneficiaries have significantly less protection than in the US or UK; in the US PBGC protects up to $55,000 of failed company pensions in case of bankruptcy. With Nortel’s pension plan having ended up being only 59% funded, modification of the Bankruptcy and Insolvency Act to give priority to pension plan underfunding over other unsecured creditors would have gone a long way to minimize the damage to retirees.

Things to Ponder

In the Globe and Mail’s “Stagflation: Scourge of the 70s stalks us still” David Parkinson writes that Don Cox sees a repeat of the 70s stagflation, but in a mutated form. In the 70s it was “the combination of high inflation (13%) and stagnant economic growth”. Today’s ‘neo-stagflation’ is more subtle; it is lower but increasing inflation coincident with incomes lagging inflation: “An OECD economic cycle in which prices of foods, fuels and precious metals rise far more strongly than prices of manufactured goods – or workers’ wages… A greater and greater share of total consumer spending goes to the commodity producers who own the farmland, the mines or the oil wells. The industrial and service-based economies find they cannot deliver the kind of strong, sustained, low-inflation economic growth that was the pattern for most of the postwar era.”

The Financial Times had a special section on ETFs this past week. In one article “Some challenges in using and creating ETFs” Ajay Makan discusses some of the difficulties (market maker stuck with underlying assets and how to price ETFs if underlying is not traded at all) that might be encountered if there is a sell-off in ETFs with illiquid underlying assets. In another article “Emerging markets: Using ETFs to invest brings risks of pitfalls” Sophia Grene looks at potential liquidity issues and indexing challenges in emerging markets.

In Bloomberg’s “Why identifying a bubble is so much trouble”John Cochrane explores the definition/identification of market bubbles (e.g. technology stocks, Florida real estate or Tulips). While it is difficult to identify bubbles when you are in the middle of it, the research into bubbles seems to suggest that “variation in price ratios corresponds to discount-rate variation, not to changes in expected cash flows or the ability to find a greater fool. The challenge is to understand that discount-rate variation.” (Interesting idea, but not sure; for example, during the internet bubble, there were no dividends/earnings to discount, only available metrics were sales or eyeballs accessing webpages.)

In Bloomberg’s “Bullion vaults run out of space on gold rally”Chanjaroan, Larkin and Roy write that “Gold bought for investment accounted for 38 percent of total demand in 2010, compared with about 4 percent a decade before, the World Gold Council estimates. Holdings in gold-backed ETPs are equal to more than nine years of U.S. mine production…Investors in exchange-traded products backed by gold bought 2,236 tons of bullion since 2003, exceeding all except four countries’ official stockpiles. All gold ever mined totalled about 168,300 tons by 2010 and would fit inside a cube measuring about 21 meters (69 feet) in length, according to the World Gold Council. Private investment in the metal reached about 31,100 tons by the end of last year. (Gold dropped $200-300 in past weeks; this might relieve (even if only temporarily) the shortage of vault space.)

On dealing with Greece’s debt crisis, if the subject moves you, you can read a couple of views in Nouriel Roubini’s “Greece should default and abandon the euro” and Martin Wolf’s “Time for Germany to make its fateful choice”

In the Financial Times’ “Investment banks’ risky business”Pauline Skypala writes that “Investment banks make money from trading in fixed income, commodities and currencies, and from structuring derivatives, among other things. They seem divorced from the real economy, and their activities have been labelled by some as “socially useless”. That might not matter if they did no harm, but it has become clear there are significant costs involved when risks are misjudged. Regulators are seeking to ensure those risks do not rebound on society in destructive ways.” (Time will tell if recently passed US legislation will be effectively implemented given the Congress’ reluctance to fund the required changes.)

BloombergBusinessWeek’s “Fidelity’s divided loyalties” asks whether conflicts of interest prevent Fidelity from pushing for better corporate governance.  “No longer mainly a mutual fund provider serving individual investors, Fidelity also serves corporations as a manager of both retirement plans and, increasingly, a whole host of business outsourcing services, from payroll to health and welfare. In theory, at least, these two distinct lines of business can come into conflict: Does Fidelity primarily serve its corporate customers, whom it would be loath to challenge over governance issues? Or does it stick up for its individual customers, whose interests might be better served by a more activist stance toward corporate management? The evidence shows that in recent years, Fidelity has forgone the opportunity to join other large mutual fund companies–even ones that offer corporate 401(k) plans–in pushing for better governance.” (Thanks to KK)

And finally, you might be interested in an upcoming CTV W5 at 7:00 PM on October 1, 2011 on Caveat Emptor when dealing with Canada’s financial industry, entitled “Who is protecting your money from financial crime?” (Thanks to Larry Elford for recommending)


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