Topics: Longevity risk, risk-free short-term rates, stock-picking robots, real estate: US and Canada down, Canada needs pension reform, longevity insurance option in CPP?  Social Security stress, pension problems disappear if you make more convenient assumptions, multiemployer pension plans an invisible crisis, Nortel bankruptcy mediation started, active management dying, financial crises caused by greed/stupidity not criminal activity? Shiller’s Financial Markets course, skip the fad, volatility ETPs high risk, eliminate speculation? fading power of equity ownership.

Personal Finance and Investments

In Benefit Canada’s “Helping employees to understand longevity risk” Gavin Benjamin does a good job explaining longevity risk to a lay-person and uses an example to get his message across about the different levels of required savings at retirement, depending on one’s assumptions of how long one might live. He indicated that a 60 year old woman retiree has an average life expectancy of 87 but 20% will still be alive at 95 and 6% at 100. The required savings targeting age 95 and 100 (rather than 87) would increase by 10% and 15% respectively. (Things are actually even worse when you consider the longevity risk of a couple, defined as the chance of at least one being alive at some age.)

John Heinzl answers a reader’s question on where to put readily accessible and riskless $500,000 in the Globe and Mail’s  “Help! I have$500,000 and I don’t know where to put it”. His suggestions include: “Winnipeg-based AcceleRate Financial, for example, is currently paying 2.1 per cent in its daily interest savings account. It’s a safe place to stash your cash because deposits are fully insured – without limit – by the Deposit Guarantee Corp. of Manitoba. For more information on coverage, click here.” Outside of Manitoba he reminds readers that $100,000 CDIC limit per institution and per account type. Vancouver’s Peoples Trust offers 2% (so does Ally).

In WSJ SmartMoney’s “Wall Street is full of ‘stock-picking robots’” Brett Arends tells the story of a couple of 16 year old scam artists who made money two ways from their claimed stock picking robot. They made money by selling a newsletter with the robot’s latest stock tips and “they also secretly raised money from penny stock promoters with the promise of pumping their stocks through the same “robot” newsletters”. After  he effectively dismisses people who might have invested in such a scheme as suckers, he then moves in for the kill that “The stock-picking robot scam is not really that different from a lot of mainstream hedge funds and Wall Street banks.” i.e. “investment banks peddle their own stock-picking skills”, “banks also take money from companies that want to sell their stocks to the public, often while recommending the stock to clients” and “they run proprietary trading desks in which they trade against the market, including their own clients”.

Real Estate

Canada’s Teranet-National Bank National Composite House Price Index shows that February Canadian home prices down 0.2% in the month and up 6.1% over the past year. “It was the third decline in four months” for the index.  Only Halifax (0.4%), Montreal (0.2%), Quebec (1.6%), Toronto (0.1%) and Winnipeg (0.2%) showed in month increases. Victoria, Edmonton, Vancouver and Calgary showed fourth or more consecutive month-on-month declines.

In the Financial Post’s Carney: House price-to-income ratio outstrips norm by 35%” Bank of Canada Governor is quoted as saying that ““mortgage rates are extremely attractive and that accounts for some of the move-up in [housing] valuation.”  But he added that consumers cannot rely on lending costs “staying there forever.” Mr. Carney said when it comes to household debt “the message is one of prudence and caution,” adding that the average home price in Canada is about 4.75 times people’s income, while the historic average is closer to 3.5. Household debt to disposable income is running at about 152.9 .”

In the U.S. according to the just out February 2012 S&P Case-Shiller Home Price Indices  “While there might be pieces of good news in this report, such as some improvement in many annual rates of return, February 2012 data confirm that, broadly-speaking, home prices continued to decline in the early months of the year… Atlanta has now recorded five consecutive months of double-digit negative annual rates and seven consecutive monthly declines. On the other hand, Phoenix has posted two consecutive months of positive annual rates, with its latest being +3.3%, and five consecutive positive monthly returns.” Only Miami, Phoenix and San Diego had positive in month price increases. Nine cities “Atlanta, Charlotte, Chicago, Cleveland, Las Vegas, New York, Portland, Seattle and Tampa — and both Composites posted new index lows in February 2012”.  Yet in the WSJ’s “Stunned home buyers find bidding wars are back” Nick Timiraos reports that according to the National Association of Realtors the “index that measures the number of contracts signed to purchase previously owned homes rose in March to its highest level in nearly two years, up 12.8% from a year ago and 4.1% from February”. Also “The Wall Street Journal’s quarterly survey found that the inventory of homes listed for sale declined sharply in all 28 markets tracked. Real-estate agents consider a market balanced when there is a six-month supply of homes for sale. At the height of the housing crisis, in 2008, there was an 11.1-months’ supply. In March, there was a 6.3-months’ supply.” NYC supply is still at 16.1 months but Miami is 4.1. Still, there are 11 million homeowners underwater with their mortgages,

Pensions

Earlier this week wrote a blog about an interesting pure longevity insurance based twist to CPP payout options that might go a long way to help ameliorate the effects of disappearing private sector pensions. This was triggered at least in part to the reignited debate between those supporting PRPP (the financial industry) and those in favour of an expanded CPP. You can read it at PRPP or expanded CPP? Consider adding a pure longevity insurance payout option to the CPP. The two recent events reigniting the debate was last week’s Ontario rethink on the subject, and earlier this week’s McKinsey report (which I still have not seen but) discussed in the Globe and Mail’s “Canada’s retirement savings system needs multipronged boost”   and the Toronto Star’s  “Older, affluent least likely ready for retirement” (unsurprisingly) suggesting that no one proposed solution (PRPP or expanded CPP) will fix Canada’s pension problems.  Also that  “The share of households that are not on track varies from as little as 4 per cent for the lower income and higher-age cohort to as much as 41 per cent for the higher income and higher-age cohort,” it says. On average, it found that 23 per cent of Canadians will have to significantly adjust their standard of living or delay their retirement if they continue on the same savings path.” 

In WSJ’s “Stress rises on Social Security” Damian Palette reports that according to latest forecasts, “reserves for the fund that pays disability benefits would be exhausted by 2016, two years earlier than projected last year. And if the disability fund were combined with the larger fund that pays retiree benefits, all reserves would be exhausted by 2033, three years sooner than projected last year. Benefits would automatically be cut roughly 25% if the trust funds were exhausted.” The Economist’s Buttonwood column “Promises. Promises” quotes from the government report that “Projected long-range costs for both Medicare and Social Security are not sustainable under currently scheduled financing and will require legislative action to avoid disruptive consequences for beneficiaries and taxpayers.. Social Security and Medicare comprise 36% of all federal expenditure; if you really wanted to shrink the state’s share of GDP, you would have to tackle those.”

I was very encouraged to read the title of the Jack Mintz’s Financial Post article “Tackle the pension problem now” but as I started reading the ‘solution’ the problem, my disappointment grew. His ‘solution’ is to stop using government bond rates for discounting future liabilities. (If you don’t like the answer, then change your assumptions. This is exactly how we got to where we are with underfunded pension plans today; make aggressive actuarial and investment assumptions to minimize employer contribution. This is all good until company goes bankrupt and the pensioners are hung out to dry. And speaking of cooking the pension books, Mr. Mintz is right, you can get whatever pension numbers you desire by persuading your actuaries….see next story.)

In WSJ’s “Multiheaded pension monster” Spencer Jakab reports that “multiemployer pension plans” in the U.S. are estimated to have $788B liabilities and only $360B asset putting them at 46% funded level. For example Safeway “Using fair value calculations, its pretax pension deficit is $7.18 billion, or more than its market capitalization. Not to worry, though: Safeway has said that its deficit is a mere $1.88 billion using federal guidelines. Since this actuarial liability determines its contributions, too, bean counters can argue about the scale of the shortfall but there is no immediate threat to cash flows… But even if companies like Safeway can continue to use generous return and discount rate assumptions, as per federal guidelines, the only way they can affect the true off-balance-sheet liability they face is through negotiating lower benefits.” But there is also the risk of failure of unrelated companies in the multiemployer plan. Off-balance sheet liabilities cannot be ignored by investors, as these will come back to bite them.

In the Ottawa Business Journal’s “Mediation start in 9B Nortel bankruptcy” Judge Winkler, the mediator “told a room full of high-priced bankruptcy lawyers, it (failure of mediation) would deplete much of the money now available to creditors, who include pensioners of the once high-flying high-tech company. “The alternative to a mediated outcome is a lengthy litigation process,” Winkler said. “This would be a catastrophic outcome for some, and unsatisfactory for most of those affected by this case.” The bankruptcy proceedings over Nortel’s business lines and intellectual property involve companies in 20 countries on every continent except Antarctica. Besides Nortel pensioners, others looking for a share of the assets include disabled former employees, bond holders, trade creditors and governments. Legal proceedings are underway in the U.S., U.K., and Canada… Hard-hit Nortel pensioners, whose pensions have been slashed by 41 per cent in some cases (actually 40% is the correct figure, have resorted to demonstrations, legal action and pressing for tougher legislative protections. Because no single court has the ultimate authority over the issue, Winkler warned that litigation could lead to conflicting results and endless appeals. As a result, he said, mediation is essential to a resolution.” (Best of luck to Canadian pensioners and long-term disabled, who unlike the U.S. and U.K. pensioners, according to Canadian law have the lowest priority among creditors and little or no pension benefit guarantee funds to make them whole. As a pensioner, I wouldn’t start spending the money from the mediation; so most (perhaps all) court decisions in this case were unfavourable to pensioners.)

And by the way, in Canada.com’s “Catalyst pensioners keep their fingers crossed” you can read about another group of 1200 Canadian pensioners who are suffering from inadequate protection of Canadian legislation after becoming victims of a bankrupt company with underfunded pension plan. As it stands right now they are in for a 30% haircut.

Things to Ponder

In IndexUniverse’s “Swedroe: Hedge funds are a disaster” Oliver Ludwig interviews Larry Swedroe (author of “The Quest for Alpha: The Holy Grail of Investing”) about his upcoming new book “Playing the Winner’s Game in Life and Investing” . (If you have read his previous book you can just imagine what he thinks of hedge funds.) While he views active investors as performing a necessary function and a ‘social good’ by helping with ‘price discovery, indexers get a ‘free ride’. Swedore concludes with the following interesting perspective “I’m absolutely convinced that active management is a dying industry. It just doesn’t know it’s dying. I’m 100 percent convinced that the trend toward indexing will continue. It will likely continue to go slowly because human beings are human beings: They all think they’re above average. They’re all overconfident, or mostly overconfident of their ability to pick stocks and time the market and find the next active manager. So, maybe it will take the 20 years for indexing among individuals to go from 13 percent to 25 or 30 percent. But I don’t think it’s going to be 70 or 80 in the next 15 years. But the trend isn’t going away. And this is really good news for investors.”

Reuters reports in the Ottawa Citizen article “Financial crises caused by: stupidity and greed”” that according to US Treasury Secretary Timothy Geithner, usually it is not criminal activity that causes financial crises. “Most financial crises are caused by a mix of stupidity and greed and recklessness and risk-taking and hope… You can’t legislate away stupidity and risk-taking and greed and recklessness. What you can do is make sure when it happens it does not cause too much damage and to do that you have to make sure you have good rules against fraud and abuse, better protections and you force banks to hold more capital against their risk”

Many thanks to VP, for bringing to my attention the Open Yale’s free online course given by Robert Shiller entitled “Financial Markets”. I didn’t as yet get a chance to listen to more than the opening few minutes of a couple of the lectures, but it looks like a worthwhile source of financial education for your consideration. Some of the lecture titles range from risk, technology in finance, diversification, and insurance to public and non-profit finance. Guest lecturers among others include David Swensen and Hank Greenberg.

In Bloomberg’s “Betting against fads in the fund industry” Lewis Braham writes that while “Imitation, the saying goes, is the sincerest form of flattery. In the financial services industry, it’s often flattery that investors could do well without: A crush of similar products in a niche market is often a sign to run in the opposite direction. The problem: When a niche fund attracts a following, others try to replicate its success. As money piles in, valuations become inflated, and the cycle continues until eventually the bubble bursts. “New fund products often follow the trend instead of anticipating it…” He discusses recent examples such as: volatility (VIX), real estate and MLP funds. The difference is typically the amount of liquidity available the asset space being considered, e.g. bonds haven’t had a problem.

Chris Flood in the Financial Times’ “Some volatility ETPs are ‘disaster’” writes that while the popularity of volatility has increased after the financial crisis, they have not been a good investment because of running costs. “Investors generally expect volatility to rise in the future so ETP providers have to continually sell low and buy high as the nearest futures contract expires and liquidity shifts into the next maturing contract.”

In the Financial Times’ “Taking the betting out of investing” Pauline Skypala refers to a recent report making persuasive arguments to “clamping down on high frequency trading, speculative trading in commodity derivatives, and over-the-counter and “dark” trading in securities”. According to the report pension funds end up at the short end of the stick with HFT, whereas on they are unwitting participants in “anti-social effects of financial markets by funneling money into commodity indices.”

In WSJ MarketWatch’s “Sallie Krawcheck: Don’t blame me” David Weidner provides an interesting perspective on financial industry insiders, who according to his cynical view are opportunists and for example Krawcheck might be considered a “born-again reformer who’s trying to stay relevant with the public and the media by taking shots at the industry that made her rich and famous… The problem…is that too many have exited their Wall Street firms and jobs with a suitcase full of money in hand. As they stride toward the town car waiting in the street they point over their shoulder at the bank and shout, or tweet, “You wouldn’t believe what’s going in there!”

And finally, in the Financial Times’ “The waning power of equity ownership” John Plender writes that “the old-style corporation worked most efficiently with pyramidal organisational structures. Yet Google’s creative employees are quirky folk for whom hierarchy is an irritation. Uniformity has no place in the network age and maybe the same goes for shareholders, too. The equity market is thus increasingly being diverted from its old function of monitoring management’s role in allocating capital.  It no longer puts up much capital for businesses like Google, which come to market to pay off venture capitalists and find a paper currency to reward employees or finance acquisitions. The fact that little capital is needed deprives the institutions of their main weapon for enforcing good governance. The curious thing about this power shift is that it is also taking place in a much older part of the market: banking.”