Hot Off the Web- May 21, 2012

Topics: Risk management, index limitations, yield dangers, retirement savings rate? working in retirement, Vancouver housing swoon, Ontario’s (Canada’s) ‘junk pensions’, restructuring a signal of pension troubles, CPP on-track and not too big? end of mutual funds? bullion problems, JPMorgan to drive Volker adoption? not just “too big to fail” but also “too big to manage”! public vs. private company organization?

Personal Finance and Investments

In my “Risk Perspectives” blog last July, I promised a follow-on blog on risk management; The Pursuit of Risk Management released earlier this week is the fulfillment of that promise. The conclusions are not as prescriptive as I might have naively hoped, but it should be food for thought in our struggle to manage risk- a clearly difficult problem, as JPMorgan will attest to.

In the Globe and Mail’s “Beware of limitations of buying the index” Rob Carrick warns readers that “the Canadian market is dominated by energy and metals” and is  heavily weighted with commodities (and financials) in general, and when those underperform, as they have done this year, it is a serious drag on the performance of those indexing the TSX. (Though I am less comfortable with the referred to ‘better’ active approaches; I would have been more comfortable with a sector weighted recommendation or even just looking at a global portfolio and assessing whether that has a sector problem; e.g. see sector and industry allocations in select markets when it was written in my October 2009 blog entitled Asset Allocation II, which would suggest that diversifying globally, for example 1/3 Canadian market (XIU) and 2/3 global stock market (VT) would also go a long way to right the sector imbalance.)

In the Financial Post’s “Danger lurks in a yield-starved world” Michael Nairne warns readers against allowing the prospect of increased income from becoming “so alluring that it causes many investors to take on more risk than they can really handle”. He looks at high-risk/junk bonds (the yield needs to be reduced by expected credit loss per year), REITs and high dividend stocks (can still be volatile and drop in value); these have a role but “that role should arise from its contribution to the return and risk parameters of an overall portfolio that matches the risk profile of the investor. It should not be determined by the quest for higher income or enhanced yield.”

The Economist Buttonwood notebook’s “A numbers game” brings a reader’s common sense/back-of-the-envelope approach to how much you must save for retirement.  “A 20 year old, expecting to work until 60 and live until 90 will work 40 years but need support for 70 years, including 30 years of retirement. He or she should therefore consume 40/70ths (57%) of income each year and save 30/70 (43%).” (Ouch!)

In the NYT’s “Working late by choice or not”  Steven Greenhouse reports that “A record 7.2 million Americans age 65 and older are working — double the number 15 years ago — partly because many older Americans love to work and partly because many feel too financially squeezed to retire. With the value of many 401(k)’s and homes taking a beating during the recession and with energy and health care prices climbing, many who dreamed that retirement was just around the corner have reluctantly kicked their retirement plans down the road.  ”

Real Estate

In the Globe and Mail’s “Vancouver’s real estate swoon deepens” Waldie and Grant report that in the Vancouver real estate market “people walking away from deposits on houses”, suggests that  “prices will fall further”, and prices in April already are almost 10% off from previous year. Toronto and Regina are still heading up (for now).


In the BenefitCanada’s “The risky business of “junk pensions”” Greg Hurst discusses the state of Ontario’s (and Canada’s) private sector DB pensions, especially when sponsor becomes bankrupt. In the context of a pensioner from one of these plans, Hurst writes that the pensioner “believed that his DB pension was properly funded and thus guaranteed and secure. He believed this because we in the pension industry—actuaries, accountants, regulators, consultants and plan sponsors—were telling people so. Well, we have been proved wrong, and the pension promises we made to Bill and potentially almost 1.7 million of DB plan members in Ontario (alone)…are in jeopardy.” The Ontario private sector pension plans solvency ratios are estimated to be 72% at end of 2011, but “ the bad news for solvency ratios is compounded for pensioners of bankrupt companies because the cost of purchasing annuities are not fully reflected in solvency ratios…I can accept this redefinition (i.e. more risk sharing between employer/employee) of the DB pension promise for those who have yet to retire, but when it comes to those pensioners whose expectations for security of their retirement income are being dashed, we should feel ashamed.” (And ashamed they should be! Read my 2009 blog Systemic Failure in Canada’s Private Pensions: Who could have prevented it? What could be done now? which discusses the failure of Nortel’s board/administrator/executives/trustees, actuaries (Mercer), investment managers/consultants (Northern Trust), custodians (Northern Trust), regulators (FSCO) and now we can add Canada’s inadequate protection of the “trust funded” DB pension system when sponsor becomes bankrupt. Shame on them all and, as Hurst says, the entire pension industry. -P.S. the fact that pension industry insiders are starting to speak out about their own failings, offers a glimmer of hope that things might change going forward; – P.P.S. the federal government continues to turn a deaf ear to the real need of pension reform in general, including the required changes to the BIA/CCAA, to increase priority of pensioners’ “trust fund” plan shortfall over other creditors in bankruptcy.)

In the Financial Times’ “Takeover cloud over pensions” Sara Silver writes corporate pension plan members in the UK “are facing a growing risk that foreign
takeovers, de-mergers, spin-offs, or financial strain will erode the ability of their sponsor company to pay their pensions in full, according to a new study”. In fact some pension advisers suggest that plan trusties should consider “mere occurrence of a restructuring as an early warning sign that the company supporting the scheme “is in trouble”.” (Great advice…pension plan members beware!)

In the Globe and Mail’s “CPPIB passes Caisse as biggest pension fund manager” Janet McFarland reports that CPPIB is on track to earn its assumed 4% real rate of return necessary to meet payout targets. “The fund’s 10-year annualized (nominal) rate of return is 6.2 per cent, but its five-year rate of return is just 2.2 per cent after years of recent turmoil in the markets. Mr. Denison said he is confident the fund will earn the average returns it needs over the long term despite recent short-term results. (CPI increase at a compounded 2.1% a year over the 10 year period). According to the CCPIB, “Despite its rapid growth over the past decade, CPPIB says it is still not a behemoth on a global scale, ranking 17th internationally among national pension and sovereign wealth funds.” (It sounds big for a country of the size of Canada’s population.) The CPPIB attributes its success to active management and private equity: “The fund’s private equity holdings in Canada, for example, earned 8.1 per cent last year, while its Canadian public equities lost 10.7 per cent. By contrast, CPPIB’s foreign private equity holdings in developed countries gained 12.1 per cent while real estate holdings earned 13 per cent and infrastructure climbed 12.8 per cent.” (Although private equity investments tend to earn a liquidity premium, but because they don’t trade in the public markets they are also more difficult value and sell.)

Things to Ponder

In an IndexUniverse interview with Ric Edelman entitled  “Mutual fund era end in sight” he suggests that retail mutual funds do not “operate in the best interest of investors”, the “industry engages in a wide variety of deceptive business practices that are designed to increase the profitability of the funds’ sponsors and manufacturers” and the “retail mutual fund industry is a dinosaur and won’t exist in 10 or 15 more years”. And reinforcing the view that low-cost passive investing has the momentum,  in InvestmentNews’ “Vanguard not only out front but now lapping the competition” Jason Kephart reports that Vanguard (specializing in passive investments) had $65B net inflow April year-to-date, accounting for 35% of the inflows of the entire industry.

Jeff Groff in InvestmentNews’ “Taking stock of bullion: Rogers says monster correction for gold possible” reports that according to Jim Rogers two likely triggers could cause the plunge in price” of gold 40-50%: if India curtails the” hording of gold” and if European central banks would decide to sell some of their stockpile or “start offering gold backed-convertible bonds”. Also James Mackintosh writes in the Financial Times’ “Gold loses its lustre” that “Gold is not only failing to provide protection against falls in the equity market. It has also stopped moving inversely to inflation-linked bond yields…yet…offers decent protection against minor crises; if saved from confiscation, it may also protect against societal collapse or hyperinflation…(but in a major crisis like potential end of the eurozone) those who bought with borrowed money become forced sellers.”

In the past week the financial paper are full with articles reporting JPMorgan’s surprise(?) loss of $2B (so far) in hedging or perhaps trading/speculating activities that went wrong.  The articles discuss the inadequacy of the technology (value-at-risk (VaR) metric based on unpredictable volatility and correlations) used to monitor a banks’ exposures, the potential impact of this on accelerating the passing of the Volker rule (for better or worse depending on your perspective) which was being fought tooth-and-nail by the banking industry led by JPM CEO Jamie Dimon. Mr. Dimon stated that his underlings violated the (not yet explicitly defined) Dimon principle which Jason Zweig replaced with the (physicist) Feynman principle essentially suggesting that you shouldn’t believe your own B.S. While $2-3B doesn’t threaten the existence of JPM, the political arguments revolve around whether banks, ultimately backstopped by the taxpayers, should be allowed to trade/speculate on their own accounts after all losses such a s these $2-3B are ultimately absorbed by shareholders (so long as the banks doesn’t go bust and starts a systemic crisis a la Lehman 2008). These are discussed in “JPMorgan loss stokes risk model fears”, “The Dimon principle”, “Polishing the Dimon principle” and “Dimon in the rough”.

In the Financial Times’ “Size matters, and matters even more” Gillian Tett points out that while the good news is that JPMorgan will have no difficulty absorbing $2B loss given its size, but the bad news is that in 2008 it became clear thatsome of the world’s largest banks were not just “too big to fail”, but also “too big to manage”” yet since 2008 the five biggest banks’ assets have risen from 29% to >50% of all U.S. bank assets. In fact “around 95 per cent of the top derivatives markets are accounted for by just five banks”.

And finally, the Economist “The endangered public company” warns that the attractiveness of the public company organization may be diminishing relative to private company organization. “The number of public companies have fallen dramatically over the past decade- by 38% in America and 48% in Britain…Like Google before it, Facebook has structured itself more like a private firm than a public one: Mr Zuckerberg will keep most of the voting rights, for example…Corporate chiefs complain that the combination of fussy regulators and demanding money managers makes it impossible to focus on long-term growth. Shareholders are also angry. Their interests seldom seem to be properly aligned at public companies with those of the managers.” The article argues that this trend is unhealthy because public companies have been “central to innovation and job creation”, are much more transparent in their operation, and “give ordinary people a chance to invest directly in capitalism’s most important wealth-creating machines”. “The public company has long been the locomotive of capitalism. Governments should not derail it.”


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