Topics: Advisers vs. salesmen, funds vs. ETFs, income splitting, wills, snowbird travel health insurance, Canadian house prices peaked? OAS costs to soar, Social Security’s huge hole, GM decision a dry-run for Nortel pensioners, collective DC plans with guarantees? Hedge funds? Roubini’s “perfect storm”, Treasuries not recommended? Occupy Wall Street vs. Unintended Consequences, ”risk-free” assets an oxymoron, BOND ETF? Libor scan known since 2008, banking rotten!

Personal Finance and Investments

In the NYT’s “A fancy financial adviser title does not ensure high standards” Tara Siegel Bernard discusses the challenges that investors face when they go for financial advice to banks or brokers even if the representatives have emblazoned on their cards impressive titles like “financial consultants, advisers and wealth managers”. “Investors can’t be blamed for failing to recognize the differences between a glorified salesman pushing a particular fund and a true investment adviser who is required to act in your best interest, but there are many.” The SEC is still writing the “fiduciary duty” rules as part of the Dodd-Frank reforms, but even if passed, investors will have to be on guard because of the nature of banks/brokerages’ business models. “As much as their firms would like to recast brokers’ images as trusted advisers, it is still hard for them to fully shed the sales mentality… Brokers, for instance, aren’t typically paid for advice — that is, they aren’t paid for creating a financial plan, and they rarely charge by the hour (though there also aren’t enough independent advisers that operate this way). Instead, they make money after they sell you something.” The greatest risk is being lulled into believing that the “broker is acting in the best interest of the client, as opposed to the firm”. The fiduciary standard, even if it won’t eradicate all abuses, should “raise the industry standard, requiring the larger firms with good compliance programs to think very carefully about whether their brokers’ recommendations could be defended in court, or before the S.E.C., as consistent with a fiduciary standard”. (That makes sense, and I am an advocate for the fiduciary standard, though the legal profession has fiduciary duty to client, but when paid by the hour an obvious conflict of interest is present. No law will replace/override the integrity of the individual you are dealing with, so choose him/her very carefully.)

The following articles should be read together: Tom Bradley’s Globe and Mail piece “Funds vs. ETFs: Peeling away some of the myths” and Rob Carrick’s   “Unethical email: Rogue sales reps or Standard insurance thinking?”. Tom Bradley (whose opinion I tend to respect) does a valiant effort in the defense of mutual funds vs. indexing battle for the heart and minds of Canadians, and argues that while “Fees are high, too many funds own too many stocks (hundreds in some cases) and too many managers hug the index rather than try to beat it. In addition, fund stewardship is sorely lacking – fund holders are often subject to manager and mandate changes, which result in inconsistent investment philosophy. There are plenty of well-managed, efficiently designed funds in Canada, but the overall fund complex is a picture of mediocrity.” But he says that the case for indexing is overstated. (Reading his arguments, which do not contain sufficient specifics to judge, I am not convinced. For example “his friends” tell him that all-in-cost is 0.5%/year to run an index ETF at an online broker; I buy ($10/transaction) and rarely trade and my Canadian index ETFs are XIU (0.17%) and VCE (0.09%), so while the average Canadian index ETF investor might have an all-in-cost of 0.5% but they probably using a different ETF and/or are very heavy traders of small transactions. By the way Bradley runs mutual funds, as he disclosed in the article, but his funds tend to be lower cost and very concentrated, so one might argue that if you are going to buy a mutual fund buy one of his, but only for the satellite portion of your core-satellite portfolio strategy, as they tend to be lower cost and more concentrated than other mutual funds.) Rob Carrick’s article on mutual funds looks at a specific instance which might give you an insight into how the fund industry works; specifically by looking at an email from an insurance company sales rep to investment ‘advisers’ telling them of ways to “sell certain products to their clients to generate maximum commission and fee revenue”. “Broadly speaking, the financial industry in Canada is based on selling products, not providing advice…. Now, here’s evidence the financial industry is working on the principle that, like suckers, there’s an investor born every minute.”

In the Globe and Mail’s “Saving tax: 10 strategies for income splitting” Tim Cestnick has a long list of income splitting opportunities, such as: higher income spouse pay household expenses and other invests, hiring family, spousal RRSP, split CPP and pension/RRIF income, and others.

In the Financial Post’s “Writing a will can be as fun as pulling teeth” Julia Johnson explains the importance of wills especially in the case of blended families. While the activity may be stressful, but “the wreckage of poor estate planning can leave children and surviving spouses at war and all of their inheritances in jeopardy”. Potential adverse scenarios mentioned include dying with the previous spouse still being the designated beneficiary on the RRSP, or “A child can unintentionally be cut out of a will — for example if a spouse didn’t realize that a will leaving an inheritance to a child will be voided by the marriage”.

The Canadian MoneySaver’s “Snowbirds, Are you ready to fly?” Bruce Cappon puts the reader through a quiz on travel health insurance for Canadian snowbirds. It covers many aspects of this essential topic for all snowbirds. Travel health insurance is one of those areas that is unnecessarily complex and that I have no doubt that few buyer of these products fully understand what they bought. For example he writes that those going to Florida for the winter, who buy a single trip policy and they return to Canada for a couple of days in the middle of the winter might not be covered on their return to Florida, unless informed they insurer, cancelled the old and bought a new policy. (I checked with my insurer who indicated that in case of my policy this is not the case, except if I sought medical help while back in Canada.) If you bought a multi-trip plan, this does not lock in your health condition for the year; most policies’ pre-existing stability clause applies to each trip, though there exist a couple of (unnamed) policies with offer this coverage. If you have a multi-trip plan you may be subject to minimum separation times between trips. (Sounds like you must read the fine print on these policies, every year, even if you are just renewing your policy. Is that a reasonable expectation? One of the problems is that unlike for life insurance policies, where the insurance company does thorough due diligence before issuing the policy, for travel insurance they do the due diligence only after a claim.)

Real Estate

In the Financial Post’s “Canadian housing prices are not sustainable: Rosenberg” you can see three charts from David Rosenberg arguing that “Canada is carving out a top, while the United States is seemingly carving out a bottom”. The charts look at three current Canada-to-US ratios compared to their historical values to support argument for a Canadian top: housing starts, national average home price, and Vancouver and Toronto relative to US home prices. (The data looks persuasive.)

Pensions

John Greenwood in the Financial Post’s “Cost of Old Age Security to triple by 2030- are Boomers to blame?” reports that Canada’s (unfunded) OAS cost will balloon in 2030 to $109B from $36B in 2010. The good news is that it will start decreasing after 2030 as Boomers start dying off in larger numbers. The recent much debated OAS changes will only reduce OAS cost by $10B/year once fully implemented. The article also reports an “interesting finding… that between 2005 and 2009 mortality rates for all seniors actually rose(!) compared to the government’s expectations (5% more men died than expected, 3% more women). While this should be good news for taxpayers (at least those who didn’t die), it is likely a statistical blip that will have little or no impact on the long-term trend toward longer lifespans.” (What if it turns out not to be noise? It’s demographics, and it should have been known for the last 60 years or so.)

In Bloomberg’s “Social Security hole overwhelms taxes, cuts” Laurence Kotlikoff, referring to a new Social Security’s trustees’ report, writes that “Table IV.B6 is a long-run balance sheet for Social Security. It shows that the system’s $88.9 trillion in liabilities exceed its $68.4 trillion in assets by $20.5 trillion (with a T)… its unfunded liability — is enormous; it is 1.4 times U.S. gross domestic product and 34 times annual Social Security taxes… To pay all promised benefits would require immediately and permanently raising Social Security’s 12.4 percent payroll tax (split evenly between employer and employee) by 31 percent, or 3.9 percentage points.”

For Nortel pensioners, who would like a warm-up exercise in preparation for the coming decision on choosing an option on the windup of their decimated pensions, might want to take a look at a video discussing a similar decision (though clearly different situation) with GM pensioners in the US. In my June 11, 2012 Hot Off the Web I mentioned that in the WSJ “Sharon Terlap reports in “GM acts to pare pension liabilities” that GM, in an effort to reduce its pension obligations, is handing “over all assets and obligations of its salaried retiree pension program and management responsibility to Prudential Financial through the purchase of a group annuity contract.” In one of the comments to that blog there is reference to Registered Investment Advisor offering services to help GM pensioners make the decision on whether to take the lump sum or the annuity option being offered. The comment refers to a video which Nortel pensioners might find interesting, as it is discussing the lump sum vs. annuity considerations like: health, male/female, taxes, current age, survivor options, lump-sum risks (principal reduction, hyper-annuation), annuity risks, portfolio considerations if lump-sum is chosen, inflation risk, flexibility and the importance of fees. By the way, this advisor indicated that his recommendation once factoring in individual circumstances of those seeking advice ended up being annuity in 60% of the cases, and 40% lump sum particularly when individual is in bad health, still has a good job or a spouse with a good job).

Ian Smith in the Financial Times’ “CDC schemes back on pensions agenda” discusses that (in the UK with the increasing predominance of DC replacing DB plans) attempts are resurfacing at giving people in with DC plans “more certainty on their retirement income…(in spite of previous contrary rulings due to) “the risk of unacceptable generational unfairness”. The so-called Collective Defined Contribution (CDC) schemes “share investment and longevity risk between members and, generally, when the pool of investments performs less well than expected, pension benefits can be reduced for some members”. They argue that such collective schemes must have full transparency and will have cross-generational impacts. Also, if some groups are affected adversely, they will choose to opt out, so if a generation is living longer, they should either pay more or get reduced benefits.

Things to Ponder

There were a couple of interesting articles in the Economist on hedge funds over the past week. (I guess the growing interest is driven by investors’ search for simultaneously lower risk, higher return and uncorrelated assets…oops, that sounds like a spec with a null solution space.) The “Masterclass” article reviews two books which “analyse what makes hedge-fund managers great—and reach very different conclusions”  as implied in their respective titles: “The Alpha Masters: Unlocking the Genius of the World’s Top Hedge Fund Managers” and “Hedge fund Mirage: the Illusion of Big Money and Why it is too Good to be True”. (I lean heavily to the conclusion of the latter of the two.) And in the Economist’s “Mastered by the universe” Buttonwood also questions the sustainable value added by hedge funds. In the “good old” days (90s), Buttonwood writes, hedge fund managers’ pitch was that they can generate outsized returns due to their smarts (notice, no mention of “hedging” in “hedge” funds), then as the equity markets became anemic around 2000 the message changed to “absolute returns” (i.e. probably implied hedging), but by 2008 when hedge funds lost an average of 20% the sales-pitch became “uncorrelated returns”. He then goes in for the kill indicating that hedge fund investors on the average should expect no more than market returns less fees because of: difficulty of identifying winners a priori, uncorrelated strategies are few and illiquid, as hedge fund industry gets larger it will be more like the “market”, and level of expenses will determine outcomes relative to “market”.

In CNBC’s “Roubini: My “Perfect Storm” scenario is unfolding now” “In May, Roubini predicted four elements – stalling growth in the U.S., debt troubles in Europe, a slowdown in emerging markets, particularly China, and military conflict in Iran – would come together to create a storm for the global economy in 2013.”

In the Financial Times’ “A crumb of comfort for investors” Gillian Tett reviews some of the Merrill Lynch investment recommendations, instead of US Treasuries, to its clients searching some stability in these turbulent times: invest in companies rather than governments, buy ETFs as a protection against inflation and increasing taxes, and global bonds. But the impact of politics has become critical yet impotent.

Robert Dupree (a faithful reader and correspondent of this blog) suggested  Edward Conard’s new book “Unintended Consequences” which according to the WSJ review “Please don’t soak the rich” by Brian Carney has a different take than Occupy Wall Street. Carney argues that “A successful economy requires outsize rewards for the able (and lucky) few who overcome very long odds to produce valuable innovations that others are willing to pay for… (as opposed to the “occupy” view that) America is dominated by a greedy kleptocracy—the 1%—that exploits everyone else, reaps most of the spoils for itself and manages to avoid paying its fair share of taxes on its ill-gotten gains.“ Carney concludes with “It is refreshing, at a time when so many take the failure of capitalism for granted, to read a bravado defense of the greatest force for wealth creation that the world has ever known.” (I haven’t read it as yet, but sounds interesting. I’d have to agree with his perspective on not having confiscatory taxes on those who are innovators/entrepreneurs and make money by bringing value to the population a large…however this does not apply to the financial industry, where ‘innovation’ tends to be mostly for new ways to fleece the unsuspecting/uninformed customers.)

John Plender argues that there is “No such thing as risk-free assets” in the Financial Times. He calls risk-free assets an oxymoron, as no assets are risk-free; e.g. inflation erodes value of fixed interest sovereign debt in addition to current negative real return on much of government debt. Yet the dollar, despite US credit downgrade, continues to be the “go to” safe haven in crisis. Plender provides the new BIS definition of “risk-free” being those assets “with a sufficiently high probability of creditors being repaid to allow credit risk not to be explicitly taken into account in investment decisions by market participants”. This is BIS’s attempt to maintain a sufficiently large pool of assets which might qualify for (relative) “risk-free” status. He concludes with “powerful headwinds militating against reversion to the mean” in yields and its timing.   

Lisa Abramovicz in Bloomberg’s “Gross losing to himself as ETF avoids gridlock” reports that the new/small Pimco Total Return ETF (BOND) has outperformed the 25 year old  Pimco Total Return Fund (a very successful $263B mutual fund) because, as a result of its smaller size, it is more nimble and can go where the 200x larger fund can’t. (This is new option for those who want active management of their US$ bond portfolio and didn’t have access US mutual funds; it doesn’t use derivatives and as an ET it has good liquidity.)

On the Libor crisis front, Bloomberg’s “Barclays revealed Libor scandal four years ago” surprisingly points out that Libor manipulation is not news. And by the way, Canadians should not be complacent since Canadian bank may not escape some damage. For example according to the Financial Post’s “Fallout from Libor scandal likely to hit Canada’s financial industry” since many investors have been hurt with overall scale of the damage being significant, the Royal Bank of Canada already sued in the US. On the other hand some legal experts suggest that “victims could a hard time convincing a court in this country (Canada), according to one legal expert”.

And finally, in case you were wondering, all is not hunky dory in the banking world’s reputation. In Bloomberg’s editorial “There is something rotten in banking” triggered by the Libor scandal, they write that while they don’t condone bank bashing “it’s difficult to defend an industry that defrauds the market with fake interest-rate figures, thereby stealing from other banks and customers… Even after the news media uncovered evidence of manipulation in 2008, the bank lobby did little to reduce conflicts or improve the veracity of its numbers… The real tragedy of the scandal is the apparent lack of ethics or self-restraint among the people involved… (this is just) the latest installment of big-bank follies offers yet more proof that the industry shouldn’t be trusted to regulate itself.”