Hot Off the Web- April 23, 2012

Topics: ETFs vs. ETNs, plain vanilla vs. synthetic ETFs, long/short funds, Pimco’s BOND ETF, real estate: Toronto-up/Vancouver-down/Canada-down, to tame Toronto RE ban foreign buyers? retirement start should track longevity, a public pension bankrupt, Nortel mediation, risk and return don’t track, VIX products irrational, dangers in life settlements, demutualization of Canadian P&Cs? Bay Street theft.

Personal Finance and Investments

In the WSJ’s “In new funds, old flaws” Jason Zweig bemoans how good ideas morph into bad ones. Specifically he warns that investors shouldn’t confuse the wonderful product like the oldest ETF, the SPDR S&P 500 (SPY) with a “newer mutation called “exchange-traded notes…have gathered $133 billion in assets…many of these “outlier products are antithetical to the original core mission of ETFs.” These ETNs are opaque, advertise high fees often over 2% yet not all costs are even included in the fee, often trade at a premium, they are tax-inefficient with income often taxed at 35% rate. Zweig concludes that “Don’t even try that (buying an ETN) unless you have a couple of hours, a magnifying glass, a financial calculator and a few pints of strong coffee. If a financial adviser tries to sell you an ETN, say simply: “Tell me what page 43 of the prospectus means.” There is a buyer for every Frankenfund—but it doesn’t have to be you.” As a matter of fact, in the Financial Times’ “Asset managers demand ETF clarity” Ajay Makan reports that BlackRock and Vanguard are asking regulator for clear discrimination between their products and synthetics with same objectives exposed to issuer/counterparty risk. In addition in the US potential conflicts of interest can exists for notes issuers, which are not permitted for ETFs

In the WSJ’s “Stock funds for the timid” Jack Hough describes the workings of emerging long/short breed of mutual funds. His example of buying $100 worth of stock and selling $50 worth short would theoretically offers increased exposure to the manager’s skill (or lack thereof) and if the market crashes you only have a net $50 exposure on the long side. He also describes the various types of long-short funds: from market neutral (no market exposure, i.e. low correlation to market) to more aggressive 130/30 funds which for each $100 of stocks bought also sell short $30 of stock. for a net $100 market exposure. “There are plenty more strategies than these that extend to different asset classes or use different tools, like options, to achieve their targets. The biggest drawback? Fees. The average expense for the long-short category as a whole is more than 2% of assets per year, according to Morningstar, compared with an average of 1.3% for U.S. stock funds…an investor who buys a long-short fund simply for crash protection is making a mistake, says Vanguard’s Mr. Kinniry. For that, “you want short-term Treasurys.””

Kirsten Grind reports in the WSJ’s “Bill Gross’s shiny new toy” that Bill Gross’s new Pimco Total Return ETF beat its benchmark (Barclays Capital Aggregate Bond Index) by 2.48% during the first six weeks of operation and as well the Pimco Total return fund it is intended to emulate. The new ETF trading under BOND symbol has collected $402M of assets. The fees of the ETF at 0.55% compare favorably with the 0.90% of the mutual fund. Gross is quoted as saying “we can’t do 2% better than the market every month”

Real Estate

In the Globe and Mail’s “Canadian real estate market a tale of two cities” Hoffman and Johnson describe the shifts that are occurring in Canada’s real estate market. Vancouver sales are off 22% in the first quarter with March prices at $761K 3.1% lower than a year earlier. However CREA data also indicates that ”sizzling” Toronto is up 10% over previous year at an average of $504K. “Nationally, the average price of a home fell 0.5 per cent to $369,677 in March from last year while sales rose 1.6 per cent.”

In the Financial Post’s “To tame Toronto’s housing ‘bubble’, ban foreign buying” Diane Francis writes that “Nearly three times’ more condo high-rises are being built in Toronto than are being built in New York City and nearly seven times’ more than in Chicago, according to Bloomberg News.” Francis opines that what is happening in Toronto is not “the market at work. This is manipulation of a government system of open-ended mortgage insurance that is poorly supervised. What is going on here is a deluge of hot money from abroad that is creating an artificial and potentially dangerous real estate bubble. This mania happened in several other countries — where it was shut down — and has spread to Canada. Officials here have been urging restraint but that is not the solution. A ban on foreign buying of residences is the only solution.” She indicates that restrictions similar to those in place in Australia, Hong Kong, Thailand, China, and Switzerland must be introduced in Canada. Also “European countries often charge foreigners twice the property taxes they charge locals”. (On this last point Canada, and European can take lessons on how to deter real estate purchasers with non-homesteaded property taxes being 2x-10x higher than that paid by homesteaders.)



Tony Jackson in the Financial Times’ “The ill-defined benefit of saving for retirement” writes  the recent poor economic environment did not cause the developed world pension crisis, it just accentuated it. The problems were there before in both public and private sectors and were caused by intentional underestimation of longevity (according to the IMF by an average of 3 years and value of this underestimate is equivalent to 50% and 25% of the GDP in developed and developing economies), by setting discount rates very high “states and corporations deferred part of the wage bills, in the belief that in the long run something will turn up”. He concludes with the thought that “…the old defined benefit promise is taken as dead. The only question is whether some middle ground can be found, such as the “defined aspiration” pension…”

In the Financial Post’s “OAS at 67: Too little, too late” Yves Guerard argues persuasively that not only was the move of OAS start from 65 to 67 should have been done before and going forward “increases in longevity must be accompanied by increases in years worked”. “When the concept of retirement first arose, people worked 30 years and then survived another 10 years or so: a three-to-one ratio. If we rediscovered this balance, we would stop thinking about increasing longevity as a problem and would appreciate it for what it really is: a remarkable gift.” This 3:1 ratio would make it easier for individuals to accumulate the asset required for retirement, would reduce dependency ratio as each additional worker simultaneously means one less retiree.

In InvestmentNews’ “In an apparent first, a public pension plan files for bankruptcy” Darla Mercado reports that the 38% funded “Northern Mariana Islands Retirement Fund filed for Chapter 11 bankruptcy protection on Tuesday.” Unlike in the case of a private company where the US PBGC would take it over, here the pension plan will have to go through a restructuring, whereby the beneficiaries will receive lower benefits than expected. This bankruptcy, while occurring in a distant US commonwealth in the Western Pacific, may set some precedents for dealing with many serious state/municipal DB plan shortfalls.

For those interested in following the progress of Judge Winkler in the Nortel bankruptcy, you can visit the Nortel Mediation website. The introductory session of the mediation process will start on April 24, 2012 in Toronto.

Things to Ponder

In InvestmentNews’ “Is Modern Portfolio Theory all bunk?” Jeff Benjamin writes that “New academic research shows low-risk stocks outperform high-risk stocks; ‘one of the most startling facts in finance’…(contrary to) a basic tenet of modern portfolio theory is that investors who are willing to take on greater risk can expect a greater reward”. Robert Haugen’s study shows that “in every one of the world’s markets, higher volatility equals lower returns”. The explanation offered by Ryan Taliaferro, pointing to another study which indicates that “stocks with lower beta, or market correlation, over the long term consistently outperform stocks that are more highly correlated to market risk”, is that “low-risk investing will continue to work as long as there are investors subscribing to the efficient market theory that risk is rewarded with returns. In essence, there wouldn’t be low-volatility stocks if investor activity didn’t create high-volatility stocks.” The article mentions Russell Investment ETFs, LVOL and HVOL in the Russell 1000 context and SLVY and SHVY in the Russell 2000 space, for those interested in exploring the idea. (Lower volatility is also more beneficial in retirement as it lowers the risk of larger drawdown and thus reduces the “sequence of returns” risk early in retirement.)

John Dizard in the Financial Times’ “Vix products are not for rational investors” argues that if the public behaved rationally then both casinos and VIX (Chicago volatility index) trading wouldn’t be in existence. However VIX trading, and casinos, are thriving since investors “are turning to Vix volatility index options and futures to manage risk and capitalise on market volatility”. The perils of using VIX hedging are readily visible as the VXX (iPath ETN)  lost 32% and 69% in the one month and six months ending in April 15, 2012. Some even fear that hedging activities of VIX sellers might even destabilize markets. Others suspect that VIX trading may have “compressed what used to be normal higher levels of volatility into a mix of a few bad days and a large number of quiet days”. The article argues that most of the time “stocks are rising or not that volatile” so you don’t want to own the index, but “on big down days…you would be buying the futures, options, or ETNs just before their price declines sharply”.  Dizard also notes that when you are buying VIX you are not actually buying “volatility” and he believes that “Vix products are neither a threat to the world financial system, nor a great way for the public to make money or protect its portfolios from real world risks.”

Leslie Scism in WSJ’s “Vulture investor battles for death-bed payouts” warns potential investors that investing in life settlements can be treacherous as insurance companies challenge validity of policies of investor held policies on other people’s lives.

In the Financial Post’s “Why your home insurance is like a lottery ticket” John Greenwood reports on the demutualization plans of some of the “106 remaining mutual property and casualty insurers in Canada with a collective surplus of as much as $6-billion… Mutual companies are essentially co-ops that are controlled by their policy holders. Many of today’ most successful insurers originated as mutuals more than a century ago, and mutuals still make up a substantial chunk of the industry.” When demutualization occurs, the policyholders who are the owners of these companies receive payouts based on the accumulated surplus of the company. However in some cases the distributions only go to a handful of the “participating policy holders”, which typically are management and directors of the company. Given that these surpluses were built over generations, some call payout only to “participating” or even all current policyholders “legalized robbery of past generations”. Management’s argument is that demutualization gives the company better access to capital markets and improved corporate governance. Mutual structure “Critics say that many mutual companies are run, not by their mutual policy holders, but by senior management, thanks to, among other things, low understanding of their rights combined with a general lack of transparency.” (The better access to public markets appears to me to be a red herring, while improved governance is not the exclusive domain of public companies. Structurally a mutual organization is better suited to work in the interest of its policyholders than a public organization with inherent conflict with shareholders.)

You can watch  a CBC  interview with Bruce Livesey (interview starts 1 ½ minutes into the podcast), author of “Thieves of Bay Street” about how Canadians are robbed blind by the financial industry in general, the lack of regulatory oversight (disgrace of no national securities regulator) and lack of enforcement (soft on white collar criminals) in Canada. (Not news, but worth re-telling; perhaps someone will listen.) (Thanks to Dan Braniff of CFRS for recommending.)

And finally, a non-financial link in case you missed it, thanks to LH for forwarding, to Canada’s National Do Not Call List where you can verify the status of the registrations of your phone (including cell and VOIP) numbers, register new numbers as well as renew the registrations for a further five years.



  1. Please read three reports out this week based on Fed studies that found:
    “Many state and municipal budgets are in woeful shape. What concerns should we have about public pensions and municipal bond markets? … we explain where risks could be building and how reforms might help forestall their impact on the broader economy and financial system.”

    1. Hi Frank…thanks for the link to your interesting blog on muni/state pensions…there is no doubt that we only see the tip of the iceberg of a crisis under way, and the longer it is left to fester, the more painful will be its inevitable resolution. My preference would be to meet existing (already earned) benefits to employees, however going forward all available tools will have to be put in motion to resolve the existing and growing funding gap. These tools would include: using honest/realistic economic and actuarial assumption to fully understand pension deficit, employee benefit reductions and/or contribution increases, the fed ending it’s “financial repression” and allowing interest rates to increase to ‘market’ levels based on supply and demand (and thus reducing pension fund liabilities due to higher discount rates), temporarily increasing muni/state taxes, and no doubt other ways. there is an elephant in the room and everyone pretends otherwise; the time to act is now!

  2. When I looked at the low volatility effect recently ( the evidence seemed quite convincing in its favour. There are lots of ETFs out there now to exploit the anomaly including one for the Canadan market, BMO’s ZLB, which bases its selections on beta instead of volatility itself. ZLB’s chart looks a lot better than the TSX’s – more stable and up 5.9% vs down 2.6% – in the scant six months of ZLB’s existence.

  3. Hi Jean…thanks for the pointer to your blog on the potential performance advantages of low volatility stocks. It is always fascinating to read things that challenge one’s existing approaches/beliefs…I will add this to my watch list of approaches, designated by some as “intelligent or alternative indexes”, which appear to provide advantages over the classical cap- weighted index whch has been the gold standard of indexing (though it is coming under attack by proponents of alternatives. The challenge of of the new approaches as usual is to prove that the performance advantage of the challengers is maintained after all costs and taxes, and most importantly whether they scale if there was a massive shift from cap-weighting to any of these. Time will tel and we (I) have to keep an open mind.

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