Topics: GMWBs, fee-only planners, work longer, junk & emerging market bonds, hybrid debt-no, retirement questions, prospect theory, scam warnings, housing bubble, no recovery for US house prices, sell and rent? Pensions: fiduciary duty & cooking the discount rates, Nortel pensioners screwed again? Inflation coming? US household formation down, hedge funds out-perform?

Personal Finance and Investments

Earlier this week, in my ‘RIP’ GMWBs? Who will miss these lose-lose products?  I discuss changes in products offered and numerous quick exits from the GMWB business. As suspected, these products which sold like hotcakes simultaneously promising upside opportunity with downside protection, turned out to be toxic not just for investors/retirees who bought them but also for the insurance companies which sold them.

In the Financial Post’s “Fee based financial planning isn’t for everyone” Fabio Campanella (a fee-based planner himself) explains that working with a fee-based planner is no guarantee for success. He runs through the reasons why: many can’t implement advice as they are not licensed to transact securities, anyone can claim to be a financial advisor in Canada as this is not a regulated industry, fee-only arrangement does not insure qualification for providing advice, fee-only arrangement does not necessarily lead to lower cost investing (fee-only planners also have to make a living) though it should. (Of course better outcomes are not guaranteed either.)

In the Financial Post’s “Resetting retirement: Getting used to longer working life” Garry Marr discusses increasing longevity coupled with low savings rates and returns, coupled with expectations of unchanged standard of living in retirement, inevitably lead to working longer or at least part time. The good news according to the article is that there are jobs. Fred Vettese is quoted that three phases of retirement are coming: (1) part-time work with travel and leisure time, (2) a more sedentary phase and (3) incapacitated and spending money mostly on medical need. (Even if you agree with the phases, the real question is how long one ends up spending in each.)

A number of articles in the past week explore investors’ search (hopefully, not over-reach) for yield. The Economist’s “Hooked on junk” discusses the potential value of a small dose junk bond ETFs, the WSJ’s “Emerging markets: The allure of bonds” suggests broadening EM horizons to include bonds both sovereign and corporate as well in local and hard currency with EM allocation recommendations of one expert at “13% of equities…and 10% of bonds”.

But in the Financial Times’ “Hybrid debt: A new old way to lose money” Satyajit Das warns that you should not fall for contingent convertibles or ‘cocos’ which combine debt and equity features. These essentially appear to be bonds, but should certain conditions be triggered, a mandatory conversion to equity takes effect at predetermined price. Just around the 2008 crash the trigger was the issuer’s stock price falling below some specified level (reverse convertibles); now the article suggests the trigger is issuing bank capital level falling below some regulatory level.

In InvestmentNews’ “Seven retirement questions all advisers should ask” Darla Mercado writes about Moshe Milevsky’s suggested questions that advisers should ask their clients. These include: how long your safely invested assets will last at current spend rate, time in retirement, value of existing pension and cost of buying an annuity, proper spend rate from nest egg, asset allocation, importance of estate, and sustainability of retirement plan.

David Parkinson in the Globe and Mail’s “Balancing act: How we misjudge risks” discusses Kahneman and Tversly’s Prospect Theory. “Prospect theory essentially argues that in situations involving financial risk, people care more about the value of their potential losses and gains than the probability of the outcomes. The result is that they can be more cautious or confident than statistical probability would dictate; they routinely misjudge the odds for success or failure… Researchers have found that investors are overconfident in their own abilities and likelihood of success; they hold onto losses for too long and sell off gains too early; and they overestimate the value of increasingly complex, “expert” information in justifying their investment decisions.” But I really love the closing quote attributed to Richard Deaves: ”The fact is that many domains are close to unpredictable…While it is true that the weather has a significant predictable component, financial, economic and political systems are much less predictable.”

In the Financial Post’s “Don’t fall for these scams” Ted Rechtshaffen list ways to avoid scams, including: “I trust him” is not enough, rates are too good to be true, money/investment must go/be-held by custodian, investment value determined by public market.

Real Estate

In the Financial Post’s “Monetary policy should not be used to tackle housing bubble” John Greenwood quotes ex-Bank of Canada Governor David Dodge who argues that Toronto and Vancouver house values are foreign investment driven and inflated property values there should not be tackled with monetary policy.

And Sherry Cooper in the Financial Post’s “Putting Toronto’s housing boom in perspective” looks at real estate markets in China, Spain, Russia and the U.S. and warns that “Too much reliance on housing appreciation for wealth accumulation and retirement security is very dangerous. Retirement nest eggs in Spain have been obliterated, and nest eggs in the U.S. have shrunk considerably. Too much household debt is also very dangerous. It increases vulnerability to interest rate risk and to economic risk of income losses or job losses…at a time when more of the population, than ever before is running out of runway before retirement, stepped-up saving and significant debt reduction are more important than ever.”

In WSJ SmartMoney’s “Why U.S. house prices won’t recover” Jack Hough has an interesting chart to argue that those waiting for U.S. house prices to recover in real terms will be disappointed. “U.S. housing had spectacular booms and busts in the 1920s and mid-2000s, but smoothing out the swings and adjusting for inflation, prices have gone nowhere for more than a century. Even more interesting is a Trulia link he refers to on price-to-rent ratios  which also include other statistics for a large number of U.S. cities.  (Readers’ comments on the article might also be an interesting read.)

In the Globe and Mail’s “Ready to be bold? Sell the house and rent” Rob Carrick reports on a Vancouver family in the mid-40s with young children who decided to sell their million dollar home and rent instead.  (Is this a sign post?)

Pensions

In Pure longevity insurance payout option in CPP would reduce retirees’ longevity risk I add some meat to the proposal I mentioned in last week’s blog on this topic. The concept is simple and for example forgoing $800/year between age 65 and 85 would transtate to an additional $8000/yr of CPP starting at age 85. 

Robin Pond in Benefits Canada’s “The precarious balance of fiduciary duty” conflicts of interest despite fiduciary responsibilities in the context of Canadian pension (DB, DC or PRPP) and concludes that “What a lot of current pension arrangements, including the proposed PRPPs, lack at the present time is an independent body that is truly concerned only with the best interests of the plan members—something like a pension advisory committee but with the authority to act. DB or DC, registered pension plan or PRPP, there is still a need to properly safeguard the interests of the plan members.” (I guess it’s never too late to close the barn door, even if some (or most) of the horses are gone.)

In the Financial Times’ “Pension schemes cannot ignore QE impact” Norma Cohen reports that the UK regulator’s answer to companies’ request for relief to use other than market rates to discount their liabilities is that replacing “mark-to-market with mark-to-model “is open to too many subjective judgments…if you pretend that the market is different, then that is a slippery slope” Instead the regulator will extend the period over which they can cover funding shortfall, in the hope that if interest rates rise then pension deficit will fall”. (This sounds a lot more sensible than the recent “just cook the numbers” recommendations of a business lobbyist in Canada.).

And speaking of cooking the books, even some in the financial industry are beginning to say that “DB discount rates overstate plan health: DBRS” (It won’t help (Nortel) pensioners, if I say I told you so about half a decade ago, but perhaps if to true state of Canadian pension system is better understood, then those in position of power to change things, will finally act.)

Nortel’s Canadian pensioners are getting screwed, again! As reported in  “CAW calls on government to reform bankruptcy legislation for equitable treatment of former employees”  “Financial speculators dealing in Nortel bonds, many of which were purchased for as little as 12 cents on the dollar after January 2009, are seeking not only the full value of those bonds, but interest as well. Some bond holders could receive 10 times the speculative investment because Canadian bankruptcy laws allow the recovery of interest for bond holders while pensioners and the disabled suffer personal and financial ruin”. And on the same topic in the Ottawa Citizen’s the Bert Hill article  “Divide and concur?” “The big problem for 20,000 Canadian pensioner, former employee, supplier and bondholder claimants is that Nortel Canada is long on claims and short on cash. Then there is the issue of bondholder demands for an outsized share of the assets. Organizations representing pensioners are mounting a new campaign for changes to Canadian legislation to stop them. But whether a Conservative majority government will be any more receptive than a Conservative minority government was in 2011 is a big question.” With $36B in claims and $7B in assets, much of the assets frozen in specific jurisdiction, and some creditors claiming against assets in multiple jurisdictions (including Canada) Canadian pensioners might, not surprisingly, again be ending up with the short end of the stick. Bondholders may end up with more than tenfold return on their speculative investment after the bankruptcy.

Things to Ponder

Martin Wolf in the Financial Times’ “About the bonfire of verities” explores the future of central banks given they now have responsibility for both “monetary and financial” stability. However it is not a slam dunk that “the propensity of the financial system towards huge crises can be halted. Indeed, the longer that success is achieved, the greater will be the complacency and the bigger may be the crisis.” And David McCrum in  “Higher inflation ahead, investor warned” quotes Bill Gross “that central bankers could not know the size of the “ocean” of credit created by their stimulative policies. Mr. Gross again warned that “not suddenly, but over time, gradually higher rates of inflation should be the result of QE policies and zero bound yields that will likely continue for years to come”.”

In Washington Post’s “Fewer Americans form households after recession, hampering economic recovery” Michael Fletcher reports that “The recession reduced the rate at which Americans set up new homes or apartments by at least half. Although the number of new households has begun to recover over the past year, its growth rate continues to lag behind its historic pace, according to Census Bureau statistics. More than one in five adults between ages 25 and 34 live with their parents or in other “multi-generational” living arrangements, the highest level since the 1950s, according to the Pew Research Center.… The slowdown has broad implications for the economy.”

And finally, in the Financial Times’ “Hedge funds in pole but is it enough?” John Authers reports that a new academic study, sponsored by the hedge fund industry based on hedge fund industry’s own data, indicates that hedge funds produce value for their investors. But Authers remains unconvinced, given the short 17 year period covered by the data and the rise in assets under management in less than two decades from $167B to $2.1T. While the industry avoided the tech-wreck, they have not distinguished themselves in the 2008 crash. Hedge funds also come with higher minimum investments, higher fees, lower liquidity, but he asks whether hedge fund managers really exploit the advantages of their business model well enough to justify the fees they charge and whether comparing themselves to mutual funds is reasonable.