Topics: Active vs. index investing, astrology vs. astronomy, “exchange traded” does not mean ”good for you”, should you care about Facebook valuation-NOT? retirement plan spoilers, bad habits, delayed Social Security, required Canadian investment regulatory changes, fiduciary duty, house prices: Canada up-US flat-Florida up, Florida housing affordable, staging homes for sale, aging pension plans, equity cult? US the best tax haven for Canadians, why retire if you are in control but then you may not be.
Personal Finance and Investments
In the Financial Post’s “The lopsided bet” Michael Nairne writes about a Journal of Portfolio Management a year 2000 study comparing after-tax performance of active vs. index investing for high net worth individuals in the U.S. between 1979-1998. The, unsurprising, result was “86% of actively managed funds had returns, net of capital gains and dividend taxes, which trailed that of the Vanguard 500 Index Fund.” The winners outperformed the index by an average of 1.28% while the laggards averaged 3.19% lower annual returns. He calls this a one-in-seven chance of winning, and if you win you get $128 but if you lose, you pay $319. This not a bet that you’d likely take!?! Nairne writes that “Lopsided bets might be exciting at the Friday night poker game. But it’s a mug’s game to make them with your entire investment portfolio.” (Canadians continuing to buy actively managed mutual funds are taking similar or worse bets with their entire retirement portfolio.) William Bernstein, in an Investment News interview “Bill Bernstein: Bernanke has been right” compares the debate between active and passive investors as that between astrologers and astronomers. (There are many other interesting observations worth reading.)
But just because the product name starts with “exchange traded”, it doesn’t mean it is good for you. In Bloomberg’s “Hedge fund ETF weapons turn dangerous for solo investors” Christopher Condon warns that “As the biggest ETF managers capture assets from traditional mutual funds with benchmark-tracking offerings, smaller competitors are catering to sophisticated investors with an increasingly complex arsenal of products. Often based on derivatives, these can be weapons for savvy investors to amplify wagers on rising or falling prices of everything from stocks and bonds to currencies and commodities. The same tools, readily available through conventional and online brokers, have proven hazardous for individual investors who sometimes misunderstand and misuse them with costly consequences.” The article also explains the differences between traditional ETFs (typically physicals backed index funds) vs. ETNs (derivatives based ETPs often opaque and difficult to understand), and provides a short historical view of ETPs. “If you are hitting a button to buy a product and don’t understand it, you probably should stop.”
In the NYT’s “Before leaping, listen to a giant” Jeff Sommer attempts to peer into the fog of pricing a company like Facebook and the high price swings on the first couple of days after the IPO by speaking with Harry Markowitz, father of Modern Portfolio Theory. His advice: ignore individual stocks and focus on ‘portfolio selection’, “buy broad low-cost stock and bond index funds instead. Allocate them in a proportion that gives you a level of volatility with which you are comfortable”.
In the WSJ’s “Are you your retirement plan’s worst enemy?” Tom Lauricella argues that otherwise well executed retirement plans can be damaged often not as a result of external forces (e.g. market crashes , illness, etc) but as a result of self-inflicted wounds, resulting in blown-up financial plans; examples include: buying an unplanned second home, helping a family member in financial trouble, under-estimating taxes, reaching for investment yield, paying grandchildren’s college expenses. (At least some of these are laudable actions, but make sure that you can really afford it, otherwise it may come back and haunt you.) In a somewhat related Globe and Mail story on “These bad habits can wreak havoc with your portfolio” John Heinzl list habits to avoid: “panicking when stocks fall”, “chasing hot stocks”, “reaching for yield”, “trading too much”, “paying exorbitant fees” and “being greedy” among others mentioned. (Great advice.)
In InvestmentNews’ “Delaying Social Security benefits ‘best deal in town’” Mary Beth Franklin reports that a new Boston College study calculates the benefit of delaying Social Security by one year with the cost of buying an annuity equivalent to the increased Social Security payment. For example a 65 year old receiving $12,000/yr could receive $12,860/yr if SS was delayed by one year; i.e. the equivalent annuity rate would be 6.7%=$860/$12,860. The study points out that this rate is higher than the 5.1% annuity rate for a 65 year old man to purchase an inflation indexed annuity; and much higher than the 3.7% annuity rate for a joint annuity if his spouse was 63. (This sounds very advantageous, especially if survivors’ benefits with Social Security do get in fact get a boost with a delay of taking SS. The catch associated with delaying SS benefits to secure future benefit boosts would be some people’s concerns relating to long-term viability of the plan, without cutbacks to promised benefits. My Service Canada enquiries indicated that CPP survivor benefit is not enhanced by dead spouse having delayed benefit start beyond age 65; in addition the combined survivor benefit and survivor’s own benefit is capped at the maximum single CPP pension in that year. A Reference Guide: Old Age Security and the Canada Pension Plan document actually explains this regrettable situation; thanks to MS for providing reference to this guide.)
In MoneySense’s “Abolish commissions for good, CFP argues” Stefania Moretti reports that Canada’s investment industry’s own self-regulatory organization (SRO) has jus issued new “regulations” called Client Relationship Model. The strongest endorsement (probably an overstatement as being an inch closer to a target a mile away is hardly meaningful) called it a “step in the right direction”. (Thanks to Ken Kivenko for bringing article to my attention. Unfortunately, this regulatory paper tiger does not address any of the fundamental regulatory changes required in Canada to protect retail investors. Examples of the required changes include: (1) an independent government/investor rather than financial industry funded and run regulatory infrastructure (i.e. no financial industry run SRO), (2) fiduciary duty toward retail investor by anyone calling themselves “advisor”, (3) a “fee only” rather “commission based” compensation structure.) And speaking of SROs, Investmentnews’ “GAO call on SEC to beef up Finra oversight” reports that the Project on Government Oversight (POGO) believes that “Finra’s (US financial industry SRO) inherent conflict of mission, its lack of transparency and accountability, and its excessive expenditures on executive compensation and lobbying illustrate why creating an SRO for investment advisers will not serve the interests of investors, shareholders, consumers or other stakeholders”.
In fact in the June 2012 issue of CanadianMoneySaver, Ken Kivenko writes in his “Why fiduciary standard for investment advisers is urgent and crucial” that “To understand the difference between a “suitability” (that basis on which “advice” is most commonly provided in Canada) and “client-first” standard (e.g. a fiduciary level of care), think of a investor seeking advice. A very common example would be if the “adviser” recommends a high -priced mutual fund with a deferred sales charge – a recommendation designed to generate the highest commission. The fund is suitable – it will satisfy the client’s needs. It isn’t necessarily the best solution and a disclosure obligation isn’t likely to stand in the way of a commission-focused salesperson. If the “Adviser” had been bound by a “best-interest”/ fiduciary standard, he would recommend a better, cheaper fund, Index fund or ETF.”
The just released April and March (as they will be releasing the data one month earlier than previously) 2012 the Canadian Teranet-National Bank House Price Index indicates that “home prices in April up 0.8% from the month before, after a 0.5% rise in March. These two consecutive monthly rises follow a period of three declines in four months… In April the composite index was up 5.9% from a year earlier.” Toronto, Vancouver, Montreal, Ottawa showed YoY increases of 10.1%, 4.9%, 4.9% and 4.2% respectively, and MoM increases of 0.8%, 0.6%, 0.8% and 0.6% respectively.
According to the just released U.S. S&P Case Shiller Home Price Indices, “The 10- and 20-City Composites posted respective annual returns of -2.8% and -2.6% in March 2012. Month-over-month, their changes were minimal; average home prices in the 10-City Composite fell by 0.1% compared to February and the 20-City remained basically unchanged in March over February. However, with these latest data, all three composites still posted their lowest levels since the housing crisis began in mid-2006…” “The regions showed mixed results for March. Twelve of the cities saw average home prices rise in March over February, seven saw prices fall and one – Las Vegas – was flat. The Composites were largely unchanged with the 10-City down only 0.1% and the 20-City unchanged. After close to six consecutive months of price declines across most cities, this is relatively good news. We just need to see it happen in more of the cities and for many months in a row.”
In Bloomberg’s “Home prices in the U.S. fell at slower pace in year ended March” Lorraine Woellert writes that “A comeback in the housing market might be under way. Homebuilders are reporting their most-improved spring selling season in seven years, propelled by record-low mortgage rates, job gains and shrinking inventories. At the same time the market faces challenges as mortgage credit is difficult to obtain and slow wage growth is keeping some would-be buyers on the sidelines.”
But the really positive housing improvement leading indicator is that according to Spencer Jakab in the WSJ’s “Housing prices show signs of stability” “Good news for real-estate agents: In a recent Gallup poll of trustworthiness, they ranked higher than lawyers, a turnaround from a 2008 survey. And they continue to leave telemarketers, members of Congress and stockbrokers in the dust.” (Pretty low bar but it is a sign, at least when you are grasping at straws.)
In Palm Beach Post’s “Homes in Palm Beach County affordable by most families” Jeff Ostrowski reports that “Housing affordability hit record levels…the typical home sold in PBC was in reach for 77.5% of PBC families” according to the National Association of Home Builders/Wells Fargo Housing Opportunity Index that has been reported for the past 21 years. While affordability is very high financing difficulty is a key current obstacle. In 2006-2007 the index was <30%.
In the WSJ’s “Set the stage for faster home sale” Amy Hoak suggestions for staging on a budget include: “a fresh coat of paint”, no empty rooms, mounted “TV as artwork”, “maintain the yard”, tidy bookshelves, “de-clutter the entire house”.
BenefitCanada’s “Aging boomers put heat on pension plans” reports that it is not just Canadians who are aging, as evidenced from latest StatsCan results survey showing that for the first time there are more 55-64 year olds than 15-24 year olds, but so are Canada’s DB pension plans. “Nearly two-thirds of respondents to a recent Towers Watson study said they believe Canada is mired in a pension crisis that will be long lasting and is only going to get worse over the coming year.” Unlike, the federal government, which has announced a gradual upward shift in OAS/GIS benefits and individuals who can (should they have to) adjust their expenditures to some degree to reflect reduction in income, pension plans do not have these options; they have legally binding commitments (tell that to Nortel pensioners) to pay specified level of pensions to retirees (with or without COLA). Companies are dependent on fewer and fewer workers to pay for the promised pensions; they will be required to increase their pension plan contributions. “There’s still time on the clock—the true test for pension plans is likely two decades away as the second wave of baby boomers reaches retirement age. “It’s 10 or 20 years before we truly know how well funded these plans are…””
In the Financial Times’ “UK pensions still ignore equity risk” Pauline Skypala discusses the excessive risks that many pension plans take, reaching for the equity risk premium while disregarding the true risk of equities even in the long term. Pension plans must take into account not just the probability of loss but also the size of the loss, which would suggest a lower equity allocation. The lower equity allocation (perhaps 30-40% rather than 70-80%) must be reflected in the default funds of DC plans.
Also in the Financial Times is Dan McCrum’s “US public pension funds take on more risk” in which he writes that unlike US corporate pensions, and Canadian private and public pensions, US public pension funds are increasing their equity and other risky asset allocations as the number of their retirees increases, because of the “perverse incentives” permitted under US regulations which then allow them to assume 7.5-8.0% returns and thus minimize their plan contributions. This going in the wrong direction since according to Skypala, just as individuals should be taking less risk as they get older, so should pension plans as they mature (ratio of retirees to workers/contributors increases). (This won’t end well.)
Things to Ponder
In the Financial Times’ “The cult of equities is dead. Long live equities” John Authers opines that while equities look cheap compared to bonds, they are not that cheap and (pension) fund managers continue to buy bonds which many consider in bubble territory because they are forced by regulators; and regulations are driven by the “financial repression” under way necessary to insure continued cheap loans to governments. So, no equity cult can reignite until the “repression” ends.
Despite the recent story about one of the Facebook founders giving up his US citizenship to move to Singapore for tax reasons, according to Robert Keats, in his latest book, he suggests that for Canadians in search of a tax haven (and warmer climate) US is the superior destination compared to traditional tax havens. You can read a short summary of Keats’ book in my “A Canadian’s best tax haven: The US” by Robert Keats blog.
And finally, in the Financial Post’s “Why do we even want to retire?” Fred Vettese argues that by looking at people like Picasso, Einstein, Kerkorian, and successful self-employed individuals running their businesses well into their 70s and 80s money is not what is driving them but being in control. Average self-employed in Canada retires at 69 but those employed by others retire on the average at 62. He also argues that many are pushed out by their employer due to high cost of keeping them around and he suggest to engage employer in exploring mutually desirable flexible arrangements like shorter working hours. Unfortunately, Mary Beth Franklin in the InvestmentNews’ “’Classic’ retirement becoming less likely” has a less rosy take of the situation of the over 60 or 65 group, when she writes that “The one-size-fits-all vision of retirement has become a victim of the Great Recession and its collateral damage to investment portfolios, home values and job security. Increasingly, employees who don’t have a pension expect to work past traditional retirement ages, if they can, as a way to make up the shortfall in their nest eggs. The stark reality is that many won’t have the choice, due to layoffs or health issues.”