Hot Off the Web– November 29, 2010

Personal Finance and Investments

In the Barron’s “A good tip for better TIPS” Ralph Goldsticker writes a  ‘Dear Secretary Geithner’ letter in which he proposes a new type of TIPS (Treasury Inflation Protected Security) to help retirees with their decumulation strategies. The proposed A-TIPS or Amortizing-TIPS, unlike regular TIPS which pay “only inflation adjusted interest until maturity”, would “make regular payments of both income and a portion of the principal, adjusted for inflation. On a 30-year A-TIP, the payments might be twice the size of those of a regular TIP. According to the author the advantages over annuities would be: government guarantee, inflation adjusted, likely secondary market for the securities, and high liquidity. (Won’t solve all the decumulation problems, for example you still need a low cost pure ‘longevity insurance’ option, but it sounds like a great idea! At age 65, combining 20-year A-TIPS with a 5-10% allocation to pure longevity insurance (which would produce lifetime income starting at age 85) would go a long way to a workable solution. Why not!? !)

Ron Lieber in the NYT’s “A dying banker’s last instructions” reviews a terminally ill ex-bond salesman’s new book “The Investment Answer” which explains “investing in a handful of simple steps”. The simple steps include: “investing in a collection of index or similar funds and dutifully rebalancing every so often” and, if necessary, with a fee-only advisor.

Jason Zweig in WSJ’s “Are index funds on track to become harder to beat?”describes how a new family of indexes will make them less vulnerable to “front-running” as (predictable) compulsory index composition changes are forcing index funds “to buy everything that is added and to sell everything that is deleted” from the index. “Any additions or deletions will be made in “packets,” or gradual steps over time, and the days on which the substitutions take effect will be randomized. These techniques should reduce turnover and poaching by outsiders while preserving the “style purity” of the indexes.”

In the Financial Post’s “Two new ETFs show their colour” Jonathan Chevreau looks at preferred share ETF choices available to Canadians. Unfortunately these funds tend to not only be very sensitive to market interest rate increases (especially perpetual preferreds common in Canada), but they also tend to be not very diversified (e.g. XPF mentioned is 84% financials…I would be careful about overindulging in these while reaching for yield; they may turn out to be riskier than perceived.)

In the Globe and Mail’s “Ten financial steps to take before you die” Tin Cestnick reminds readers of items that people should prepare to ease the work of executors, such as: an up-to-date will, a complete list of assets (and holding institutions), potentially pre-pay funeral, life insurance and insurances advisors’ name, registered plans with desired  named beneficiaries.

Jonathan Chevreau in the Financial Post’s “Dollar-hedged funds come at a high cost”discusses some of the pro and cons of and approaches to currency hedging embedded in some funds. The bottom line is that to hedge or not to hedge is a complex issue, especially since the direction of exchange rates is so unpredictable, hedging costs are non-trivial, and what is being hedged is not what you might think especially for global funds. Some advisors suggest that investors consider partially hedged portfolios. (I personally don’t hedge any of my portfolio because different underlying currencies in the portfolio are just an additional form of diversification, over the long term, currency exchange rates tended to revert, I don’t know the direction of currencies and hedging might actually hurt performance, and perhaps about 40% of my expenses (liabilities) are not in CAD, and the vast majority of my fixed income allocation is in CAD. My approach certainly hasn’t helped my returns as the CAD was appreciating against the U.S. $ and other currencies, but I am sticking with it.)

And speaking of exchange-rate fluctuations, Tom Bradley in the Globe and Mail’s “Much maligned greenback is looking
increasingly cheap”challenges the current thinking that momentum (China growth, gold, oil exhaust, Japanese no growth, falling U.S. dollar) will continue forever. He specifically argues that the U.S. dollar is in fact undervalued relative to loonie on a purchasing power parity basis (should be trading in the range of 0.81 and 0.84, rather than parity). Based on his recent U.S. trip, he suggests that “the U.S. is unbelievably cheap” (especially so if you come from Toronto). “Opportunities to purchase hard assets in the recession-ravaged U.S. are at hand. As a result, I recommend you follow my lead and do a little southern sleuthing this winter.”

Real Estate

The November Canadian Teranet- National Bank House Price Indexreflecting the September 2010 data indicating price declines in all six markets covered with an overall year-on-year drop of 1.1%. “The (month-on-month) declines were 2.4% in Halifax, 2.2% in Calgary, 1.6% in Toronto, 0.5% in Ottawa, and 0.3% in Montreal and Vancouver.”

Julian Beltrame in CB Online’s “Canadian home prices should ring alarms, says leading U.S. expert” reports that housing expert “sees no reason why average home prices in Canada should be about 50 per cent higher than in the United States. Noting that average incomes in Canada are lower than those in the U.S. and land values are not appreciably higher, the fundamentals don’t justify the price premium”. Further commenting on Canadians’ high debt to income ratios, he indicates that “Canada could see house prices collapse by 25 to 30 per cent if interest rates rise by about two percentage points”. Not all analysts agree that Canada is in for a U.S.-like housing crash, due to ‘quality of debt’ differences from the U.S. (Referred to by Rob Carrick’s Personal Finance Reader.)

In the NYT’s “U.S. home sales fell sharply in October” David Streitfeld reports that “sales of existing homes plunged 26 percent in October compared with the same period last year”. “Distressed sales, including foreclosures, have been about a third of the market, while first-time buyers have been as much as 50 percent. Both are high by historic levels.” (Referred to by CFA Financial News Briefs)

Pensions

In WSJ’s “Pensions: The lump sum gamble”Ellen Schultz reports that in the U.S. “More than 90% of employees opt for a lump-sum payout from their pension plan when given the choice. That could be a mistake.” Under new rules companies have been calculating commuted value (CV) payouts using much higher discount rates based on corporate rather than Treasury bonds. This can result in 10-60% lower CV payouts, and employers are not required to notify employees about the change. Americans (unlike Canadians) worried about their sponsoring company going bankrupt, should think twice about taking CV, especially since PBGC guarantees pensions up to $54,000. Also, unlike in Canada, if the sponsor is in bankruptcy then CV is not a permitted option for a departing employee in the U.S.

Vahe Balabanian of the NRPC’s (Nortel pensioners’ and ex-employees’ protection group’s) political action committee, reported in an email on the November 25, 2010 meeting on Canadian MP John Rafferty’s private member’s Bill C-501  intended to provide “priority” in bankruptcy for pension plan deficits. He reports that when Mr. Rafferty asked for a (very sensible) change of “super-priority” to “preferred” status for pension fund deficit, Conservative House Leader John Baird refused in an attempt to try to kill the Bill at the Committee level. The next Committee meetings are scheduled for Nov. 30, Dec. 2 and Dec. 7; Balabanian indicates that there is still opportunity to send more submissions and attend the meetings. (Please consider doing so.)

Also, ex-Chief Actuary of the CPP Bernard Dussault sent a note to Financial Post personal finance reporter Chevreau about unfairness of increasing the age when Canadians can receive unreduced Canada Pension Plan from age 65:”it would be totally unfair and irresponsible to increase the age (65) at which regular CPP retirement benefits commence, unless the CPP 9.9% contribution rate would be reduced appropriately. If it were not for the insufficient CPP contributions paid until 1996, the CPP contribution rate would stand around 6% rather than 9.9%. As current and future CPP contributors are already overpaying to CPP to account for the unfunded benefits granted to their predecessors, they should in no way be further penalized by having the commencement of their CPP retirement benefits deferred by two years.”

Things to Ponder

CARP’s Advocacy bulletin summarizes Michael Bliss’s report on the inevitable need for governments to cap expected increased rate of growth in healthcare expenditures in “Means tested healthcare”. He suggests means testing and new forms of healthcare premiums should be considered. You can also read it in its entirety at Michael Bliss’s C.D. Howe Institute Lecture.

In the Globe and Mail’s “Number of seniors living in poverty soars nearly 25%”Joe Friesen reports that “The number of (Canadian) seniors living in poverty spiked at the beginning of the financial meltdown, reversing a decades-long trend and threatening one of Canada’s most important social policy successes.” CARP’s Vice president of Advocacy Susan Eng argues that “Instead of helping, government rules actually exacerbate the problem. Applying late for OAS, GIS or CPP, limits you to11 months in retroactive payments – of your own money. Eighteen percent of women over 65 who live alone live in poverty. It didn’t help that the OAS spouse allowance for those aged 60-64 was not available to them.”

John Gapper in the Financial Times’  “The Feds must cast their net widely” reports that comments by US attorney for New York as saying that “illegal insider trading is rampant”. He is also correct that some of the miscreants are “among the most advantaged, privileged and wealthy insiders in modern finance”.” However he argues “The fact that some investors dig out facts that companies do not want them to know – and thus gain an advantage over the rest of the investing public – is not illegal nor unethical in itself. To the contrary, it is to be encouraged.”  In Bloomberg’s   “Expert-broker Chu steered hedge fund to Asia, U.S. says” Christopher Condon looks at the same topic and reports on incriminating FBI recordings of conversations which suggest that real insider information was in fact trafficked in.

In the Globe and Mail’s “Contrarian sees salvation in Treasuries”Martin Mittelstaedt quotes Gary Shilling that he “is convinced the United States is about to slip into a lengthy period of weak economic growth, accompanied by 2 per cent to 3 per cent annual deflation – an unusual situation in which consumer prices fall steadily… Equities will produce anemic returns not much more than their dividend yields… U.S. house prices could tank another 20 per cent… his perennial favourite, long-term U.S. Treasuries, now yielding about 4.25 percent, that he contends will be big money spinners”. If rates drop to 3% as he suggests then a 27% gain will result.

In the Financial Times’ “Fundamentals of index investing” James Mackintosh asks whether it makes sense to invest in cap-weighted indexes in light of the “ample evidence” that that markets are inefficient. He then proceeds to discuss the new fundamental indexes (similar frequent outperformance by value stocks) which (after many years of underperformance) have recently started to outperform. The costs associated with fundamental indexes listed include: higher volatility, lower liquidity, higher smaller company content and higher trading costs (and possibly higher tax costs); recently the extra returns more than covered costs. Mackenzie suggests that so long as value works, go for it. (?) On the other hand Pauline Skypala, also writing in the Financial Times, in “David Booth: A firm believer in market efficiency” reports that “One form of indexing he does not favour is the fundamental variety, where constituents are weighted by factors such as book value, earnings or dividends rather than by market capitalisation. It is a version of the value effect, he says, and more like active management than what Dimensional does.” (So there you have it; a clear recommendation on going with capitalization weighted index vs. a fundamental indexes. Oh well; we’ll just have to make up our own minds. I haven’t just in as yet, though fundamental indexing has some intuitiveness to it.)

And finally, “Inside Job”is a new documentary built around interviews with financial industry insiders, which left me angry and scared. The documentary takes the viewer through the events leading up to and through the most recent financial crisis. The root causes explored were the ones that we already heard about before: the systematic dismemberment of the regulatory environment in the last 30 years including the gutting of the SEC, the introduction of various derivatives (CDOs, CDSs,…), the double dealing by many of the financial industry in the name of “market-making” (while some of this may be justified with appropriate disclosure much of it is not), reckless risk-taking by banks increasing their leverage from historically <10 to >30 in the interest of short-term profits leading to immediate gratification via enormous bonuses to be soon followed by firm’s bankruptcy or near-bankruptcy requiring  government bailout. All of this was enabled by the three rating agencies (Moody’s, S&P and Fitch) who in retrospect consider their ratings just “opinions” (how come that they are still in business?), and university professors writing “research papers” in return of outsized “consulting” fees selling their souls to the financial industry (without disclosing the fees/source which paid them to write the articles), and that financial “engineering” unlike real engineering adds little or no value to society. And worst of it is, according to the documentary, that nobody has, as yet, been jailed.  The result is that in U.S. society, wealth is most unequally distributed of any developed countries, with 1% of the population now owning 23% of wealth.

So why has this documentary  left me angry and scared….and I really couldn’t figure out why since it contained no new information that I wasn’t aware of….so I asked my wife for an explanation of my emotions…she didn’t even bat an eye, just said that it is “because they did what they did knowingly (driven by greed), they are still in positions of power and influence…and really nothing has changed”…(the “consultant” professors, the financial industry “advisers” to the government, the massive financial industry lobbying machine…and lack of real regulatory reform)…I think she might  be right… (…and by the way I am in the middle of reading Al and Mark Rosen’s new book “Swindlers” in which he says that Canadian regulatory environment and enforcement is much weaker than that of the U.S. and is getting weaker as we speak due to the coming adoption of IFRS accounting rules…this is all very depressing.) If it’s playing in your neighbourhood, I recommend that you go see “Inside job” and judge for yourself. (Thanks to Larry Elford who suggested that I go to see this “documentary”; by the way Larry also has a new mini-documentary (25 min.) www.albertafraud.com  on how Alberta regulators and politicians are aiding, abetting and even encouraging the financial industry to get around existing legislation to take advantage of investors.)