Hot Off the Web- November 28, 2011

Personal Finance and Investments

In the Financial Post’s “Charles Ellis to Canadian portfolio managers: fees must come down” Jonathan Chevreau quotes Charles Ellis (author of the must read “Winning the Loser’s Game- Timeless Strategies for Successful Investing”) as follows: industry should abandon “the futile quest to “beat” the market’, even 1%/year is too high (never mind the 2.5% MER charged by the typical Canadian mutual fund), not against fees so long as they are not for security selection but for something useful like “giving good advice and figuring out who you are” (I interpret that to mean a financial plan), fundamental investing and small-cap effect are just “value stock” effects, he is comfortable with capitalization weighted indexes, “managers can add value through asset allocation, portfolio structure and other things apart from security selection”.

In the Financial Times’ “Star stock pickers struggle to beat index”Makan, McCrum and Mackenzie write that the past year has been a disaster for some of the world’s best know investors and stock pickers: Bill Miller, John Paulson, and Bill Gross. Stocks have been moving in sync with the market and while there are lots of cheap stocks out there nobody knows when (and if) they will be recognized. (A broad index ETF might do the job instead; eventually more and more people will figure it out.)

In the Nov-Dec 2011 issue of CFA Magazine Susan Trammell reviews William Sharpe’s  award winning paper on “Adaptive asset allocation”whereby he describes a method for doing portfolio rebalancing which “readjusts the major asset class weightings not in relation to constant, predetermined proportions- the traditional asset allocation approach- but relative to their proportion to total market value…(this) implicitly recognizes an investor’s risk appetite relative to, not irrespective of market proportions”.  Sharpe’s arguments for making this change to the traditional rebalancing approach is based on some very sensible arguments like: traditional approach is not implementable if all investors tried to follow it since the traditional contrarian approach requires counterparties for trade execution who are trend followers, practitioners of traditional rebalancing based on contrarian approach to transactions will outperform buy-and-hold strategies in a market of frequent reversals, but will lag in upward trending markets (and people don’t even realize this implication of the contrarian approach), and that most people are not rigorous about rebalancing anyways. His proposed approach actually involves less trading to bring portfolio to new allocation. “Rather than thinking of an aggressive fund in absolute terms, it might be thought of as one that provides relatively more risk than the market at all times. One of the problems with the proposal is that there is a lack of data on the market weightings for the asset classes. The formula in a two-asset class case situation is explained in the article.

Rob Carrick in the Globe and Mail’s “Reverse mortgages are set to rise, unfortunately” writes that “The more financially unprepared you are for retirement, the more likely it is that there’s a reverse mortgage in your future…. The points against reverse mortgages include hefty set-up fees and higher than usual mortgage rates.” One financial adviser quoted (appropriately)  called it “lender of last resort” (You can read one of my old blogs on this subject at Reverse Mortgages)

Real Estate

The Economist’s “House of Horrors, part 2”suggests that when house price-to-income and price-to-rent are both well above their long-term average that it could be a signal of overvaluation. According to a metric based on the average of these measures Canada’s housing prices are among a half dozen countries considered 25% or more overvalued. The article indicated that “Prices do not necessarily need to drop sharply to return to fair value. Adjustment could come through higher rents and wages. With low inflation, however, it could take a decade or more before price ratios return to their long-run average in some countries….Canada… (has an) even higher household-debt burdens in relation to income than America did at the peak of its bubble. Overvalued prices and large debts leave households vulnerable to a rise in unemployment or higher mortgage rates.”

In the Palm Beach Post’s “Home sales leap 27% in Palm beach County over past year”Kimberly Miller reports that October sales were -15%/-9% lower MoM but 27%/13% higher YoY in Palm Beach County/State-wide. Palm Beach County median prices were -16% lower than previous year.


In the laughing stock of the week (or year) category Statistics Canada issued a report entitled “Income adequacy in retirement accounting for the annuitized value of wealth in Canada” where they argue the 65+ age group would actually be better off than the younger age groups if they only sold their homes and annuitized all their assets or took out reverse mortgages. Among the ‘minor’ problems with the report are: the use 1999 data for assets (conveniently disregarding that 1999 was a peak year of market valuation, since then followed by ‘minor’ market reversals in 2000 and 2008-2009), and assuming annuity rates in the 7% region. Further criticism of the ludicrous Stats Canada report can be found in Jonathan Chevreau’s Financial Post article “Annuitizing wealth closes retiree income gap, study says”.

In Benefits Canada’s “Who is responsible for your pension plan?”Brooke Smith reports from a seminar on fiduciary responsibility for pension plans that “In terms of actuarial assumptions and methods, who is responsible for the ultimate decision? In a single employer pension plan, for example, the board or senior management (as delegated by the board) may decide on the assumptions and methods to be used. However, regardless of who makes the decisions, it is the board that’s ultimately responsible. The board won’t escape liability just because it delegated decision-making…” (You might want to ask why in the case of Nortel would the CCAA court judge force and Nortel pensioners accept a Settlement Agreement which effectively eliminates the possibility of suing the Board, Officers and the company for not meeting their fiduciary duties toward pensioners? Or you might ask what kind of pension laws does Canada have which effectively indicate that these actors have simultaneous and conflicting fiduciary responsibilities to pensioners and shareholders? Or laws which, according to this article, might (though not explicitly) suggest that ‘professionals’ (actuaries, investment managers, custodians and even regulators) owe no fiduciary responsibility to pensioners and other plan beneficiaries; some might say that this must just be the ‘legal’ system which appears unrelated to a ’ justice’ system.)

Things to Ponder

The Economist asks “Is this really the end?”and answers that “unless Germany and the ECB move quickly, the single currency collapse is looming… A euro break-up would cause a global bust worse even than the one in 2008-09. The world’s most financially integrated region would be ripped apart by defaults, bank failures and the imposition of capital controls… Yet the threat of a disaster does not always stop it from happening. The chances of the euro zone being smashed apart have risen alarmingly, thanks to financial panic, a rapidly weakening economic outlook and pigheaded brinkmanship. The odds of a safe landing are dwindling fast.” (Thanks to CFA Institute Financial NewsBriefs for recommending.)

In Bloomberg’s “MF’s missing money makes you wonder about Goldman” Jonathan Weil writes that PricewaterhouseCoopers six months ago indicated that MF “maintained, in all material respects, effective internal control over financial reporting as of March 31, 2011.” A lot of people who relied on that opinion lost a ton of money. MF Global filed for bankruptcy on Oct. 31. This week the trustee for the liquidation of its U.S. brokerage unit said as much as $1.2 billion of customer money is missing, maybe more. Those deposits should have been kept segregated from the company’s funds. By all indications, they weren’t. “ Goldman Sachs and JP Morgan Chase also use PricewaterhouseCoopers New York office for audit. “The point of having a report by an independent auditor is to assure the public that what a company says is true. Yet if the reports aren’t reliable, they’re worse than worthless, because they sucker the public with false promises. Maybe, just maybe, we should stop requiring them altogether.” And in a related WSJ story entitled  Jaennette Neumann reports that ““Rating firms’ MF Global role to be explored”given that “Moody’s and Fitch cut their investment-grade ratings on MF Global only days before the brokerage firm filed for Chapter 11 bankruptcy protection, and Standard & Poor’s did so only after the bankruptcy.”

In Business Insider’s “The run on Europe begins, as global investors head for the hills…” Henry Blodget writes that ” Until recently, the concern about Europe has been mostly theoretical–a potential train-wreck that would occur if/when the world’s lenders decided that the continent’s problems extended beyond the basket case known as Greece and cut lending to Europe’s “core.” Well, that concern is no longer theoretical. It’s happening. The world’s lenders are increasingly deciding that it’s better to be safe than sorry, and they’re pulling their money out of Europe.” (Thanks to MB for referring the article.)

In the Financial times’ “Super-Mario and co to the rescue” James Mackintosh writes that investors are delighted by the likely spread of Quantitative Easing (QE) from US to UK to Japan and now Europe. The expectation is that lower rates will lead to both higher bond and stock prices, but in fact the opposite happened; as interest rates decrease, so did stock prices. The rates in the US, UK, Japan and Switzerland can’t fall any lower, so if central banks want to affect equity prices they’ll have to follow the example of the Bank of Japan which started buying equities in 2002. Nevertheless, Japan equity prices are down 8.8% since the central bank started buying equities.

And finally, Niall Ferguson in “2021: The New Europe” “peers into Europe’s future and sees Greek gardeners, German sunbathers—and a new fiscal union. Welcome to the other United States”


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