Topics: Elder abuse, hedge funds add no value, financial certification rating, fiduciary, RESP fees, short-sales to drive real estate prices? US house sales/prices up, pensions underfunded, PRPP promotes DB closure, PRPP=RRSP, financial industry needs government help on annuities, index funds bad say active managers, Gross wrong on equities, food prices and commodity speculation.

Personal Finance and Investments

In the USAToday’s“Elderly suffer as financial abuse grows” Christine Dugas reports that “Financial abuse of the elderly is getting worse, and most seniors don’t know how to seek reliable financial help… The experts IPT surveyed said the most common type of abuse is when family members steal or divert funds or property. The next biggest problems are caregiver theft and financial scams perpetrated by strangers… It is critical to train primary care physicians to pre-emptively identify older adults who are at risk for financial exploitation.”

In the WSJ MarketWatch’s“Why hedge funds may not be right for you” Brett Arends enumerates reasons why hedge funds, often called “absolute return”, “total return” or “market neutral”, don’t deliver as advertised. In the past 5 and 10 years the hedge funds still in existence, keeping in mind that “most have dropped off the radar along the way”, had median returns of 23% and 104%, respectively; a 60:40 benchmark portfolio returned 15% and 119% (recall most of the hedge funds were not in the survivor statistics). “When you are a hedge fund investor, you want to invest in the top 1 or 2 %,” says Brendan O’Brien at Gold Coast Wealth Management. “These guys really do outperform the market across five or 10 or 15 years.” (Good luck in trying to identify them a priori.)

In Financial Planning’s “CFP board seeks measures to protect seniors from financial abuse” Anne Marsh writes that a survey of 1,649 CFPs “found that more than half of the certified financial planners who participated have worked with an older client who has been subject to unfair, deceptive or abusive practices in the delivery of financial advice or the sale of financial products”. The CFP Board has asked the Consumer Financial Protection Bureau “to create a ratings system for financial certifications and designations”. There are 142 financial advisor designations and “most of them actually have nothing at all behind them other than a weekend course with an open book test…they are basically worthless”. And a related story entitled “Volker joins finance leaders calling for fiduciary expansion”reports that Paul Volker, John Bogle, Arthur Levitt and Daniel Kahneman are among the financial luminaries, who signed a petition which calls for “evenly applying the fiduciary standard to all advisors and broker-dealers who render investment advice.” “Fiduciary advice is right for investors. The trust it engenders is essential for capital markets” according to Knut Rostad, president of the Institute for the Fiduciary Standard.

In the Star’s “Fees eat up 90% of RESP refund after baby’s death” Ellen Roseman writes about a couple whose baby died due to a rare disease and not only were they forced to close the RESP account but after depositing $2,730, they got a refund of $287, with the balance being eaten up by fees. The group RRSP was with Children’s Education Funds Inc. (Thanks to Ken Kivenko for referring the article.)

Real Estate

In WSJ Market Watch’s“Will short sales hit home prices” AnnaMaria Andriotis reports that the new guidelines of US Federal Housing Finance Agency will ease short-sale of properties. Included in the guidelines is that those with FNMA/FHLMC mortgages will be permitted to pursue short-sales if they have a hardship (loss of job/divorce) even if they have not fallen behind on mortgage payments. But while US home prices have been rising “due to limited inventory and the smaller number of distressed properties on the market”, “experts say they could negatively affect prices in neighborhoods that get an influx of new short sales.” A rise in short sales will result in “downward pressure on home prices until we clear out the majority of these distressed properties”.

In Bloomberg’s “Sales of U.S. existing home sales increase from eight-month low” Shobhana Chandra reports that according to the NAR “Purchases of previously owned houses, tabulated when a contract closes, increased 2.3 percent to a 4.47 million annual rate (from June)… Compared with a year earlier, purchases increased 11 percent … The median price of an existing home jumped 9.4 percent from a year earlier, the biggest 12-month gain since January 2006, to $187,300 from $171,200 in July 2011…”

Pensions

In the Financial Post’s “Pensions veer into danger zone”Barry Critchley writes that according to a new DBRS report on 451 Canadian and U.S. defined benefit pension plans which have a combined deficit of $389B and “more than two-thirds of plans reviewed…were underfunded by a significant margin.” The report also refers “to the issue of where pensions should rank in capital structure given that a bill, Bill C-501 is working its way through Parliament, and a lawsuit concerning Indalex Ltd. has been filed”. The latter is before the Supreme Court. “In both cases (assuming the Supreme Court goes along with a decision from Ontario’s Court of Appeal), pensioners would have a higher priority than they do now.” (While this is not news but it is worth reminding legislators about the exposure faced by pension beneficiaries if companies go into bankruptcy. This is urgent and must be made retroactive at least to January 1, 2009 to protect Nortel pensioners who are still under threat of being pillaged by bondholders- see “Nortel bondholders poised to get $1.25/dollar while pensioner might get $0.15/dollar?”)

Greg Hurst in Benefit Canada’s “PRPP inducements: What they mean for employers” writes that “Pooled registered pension plans (PRPPs) will be attractive to employers that wish to shed the risks associated with the fiduciary obligations for employers that offer traditional retirement programs.” The new draft PRPP regulations allow “employers to demand, or PRPP providers to offer, inducements to transfer membership and assets from traditional plans to a PRPP”. Hurst asks “What are the federal government’s purposes for the permitted inducements?” “The availability of inducements to promote PRPPs may well prove to make them successful; however such will be at the cost of cannibalizing existing traditional programs without any assurances of effectiveness in expanding private sector pension coverage in the absence of requirements for mandatory pension coverage.”

In a  new C.D. Howe report entitled “Annuities and your nest egg: Reforms to promote optimal annuitization of retirement capital” Norma Nielson argues that Canadians don’t annuitize enough for their own and society’s good even though Canadian annuities are priced ‘fairly’ and ‘reasonably’. Therefore she asks for government support of financial industry on: (1) collection of mortality data, (2) bonds for hedging duration/longevity/inflation risk, (3) level playing field between banks, insurance and financial companies, and various decumulation products on: regulation, taxation, guarantees, solvency/capital requirements, (4) government information websites to encourage or even mandate the use of annuities in for decumulation. (While it contains interesting Canadian annuity related information and there are some individuals who might bet value from annuitization, a call for a massive government push to indiscriminately increase or even mandate annuitization to increase the financial industry’s annuity business, sounds more like a lobbying thrust on behalf of the industry as its mutual fund and structured product business related fees are being eroded by indexing and ETFs. If/when annuities are the right answer, it would make more sense to look at the problem from an annuity buyer’s rather than industry’s perspective, and the solution would be much simplified by removing financial intermediaries from the annuity equation. A better solution would be to buy a pure longevity insurance annuity (single premium at 65 with annuity payments starting at 85); this requires that annuitant give up about an order of magnitude less assets to receive a similar lifetime payout starting at age 85, than if payout start at 65). Between ages 65-85 the retiree could manage the unannuitized assets with less corrosive fees, without having to give up control of the assets and with longevity risk mitigated/absorbed by the annuity stream that kicks in starting at age 85. Recent actual U.S. quotes for such insurance products indicate that even in the current ultra-low interest environment, a single $1 premium at age 65 would buy about $0.64/yr life contingent income stream starting at age 85; but such products are not available in Canada and the government could enable or offer them directly. And yes, even better approach would be to for the government to simply provide the annuities directly to Canadians; this could likely be done at the cost of <1%/yr within the CPP framework. An even simpler approach would be to just add a longevity insurance payout option by foregoing a portion of one’s CPP benefits until age 85, in addition to the already existing flexibility to start CPP at any time between age 60-70. (This was described in “Pure longevity insurance payout option in CPP would reduce retirees’ longevity risk”.) Any concerns about longevity risk could simply be dealt with adjusting payouts up/or down should mortality data turn out to be more/less favorable than built into the plan (required adjustment would likely be small). Legislating fiduciary responsibility by all those calling themselves ‘advisors’ would be an important step toward addressing Neilson’s other concern that financial advisors, in an effort to maintain control over client’s assets, are impeding annuitization (though I suspect that most of the time the advice is appropriate). And finally, in the interest of all insurance (and financial product) buyers the government should take steps to reverse the demutualization of insurance companies which took place in the 90s; clearly, as many in the industry have predicted at the time, demutualization turned out to be a significant deterioration of the financial outcomes for the insurance company customers, given the shift from management having a fiduciary responsibility to policyholder to shareholders. As to calling Canadian annuities as ‘fair’ and ‘reasonably’ priced, some might disagree since buyers are trading the present value of government guarantee for an insurance company guarantee, beside the fact that very few if any individuals would not lock in their life savings in medium/long-term government bonds at potentially zero real return. )

Another C.D. Howe report entitled “Ottawa should rethink rules to vastly improve PRPPs” Pierlot and Laurin write that “As currently proposed, PRPPs present only the appearance of reform because they are for the most part a re-release of an existing retirement savings vehicle -RRSPs – with a new coat of paint” and they call the PRPP a new tax on the poor;”… PRPPs should be avoided entirely by many low- to middle-income workers, who will face taxes and government-benefit clawbacks on PRPP retirement benefits at rates that are significantly higher than the refundable rates that apply to contributions.” (You can read my assessment of the PRPP by reading “PRPP: An agreement to kick the can down the road and deliver more fees to Canada’s financial industry”)

Things to Ponder

In the Globe and Mail’s“Index funds cost a lot more than you think” Fabrice Taylor starts off his article with “There is nothing more self-serving than what the conventional financial industry tells you to do.” He then proceeds to argue that financial firms love index funds and ETFs in particular (I doubt it) and proceeds to quote financial industry insider  “Stephen Takacsy of Montreal’s Lester Asset Management…(that) there is little or no quality control over what companies are admitted into an index. It’s mostly a function of size and volume.”  (No doubt, Mr. Taylor would tell us to take the industry insider’s self-serving gripes about index funds with a grain of salt, as well.) Yet in the WSJ Market Watch’s “ETFs become surprise mutual fund holding” Ian Salisbury reports writes that “it might come as a shock to some investors that the top holdings of several major stock (actively managed) mutual funds are actually ETFs…When the market plunges…fund managers say, they own an ETF, which is easy to sell and lets the fund keep the stocks it really likes.”

Another attack on (capitalization weighted) indexes, despite its deceptive title, is IndexUniverse’s“Arnott: Emerging markets still look good”where Rob Arnott originator of “fundamental indexing”, calls the father of indexing John Bogle his friend and one of his heroes in this business, but then proceeds to argue that Bogle’s traditional indexing is passé and in fact it, rather than fundamental indexing, is active management because capital weighting leads to an allocation in the index which is radically different than one based on contribution to the economy (i.e. GDP), thus Arnott’s “fundamental indexing is the real passive strategy and cap-weighting can be a huge active bet. Arnott argues that despite higher costs his fundamental indexing approach delivers a long-term 2%/yr advantage of cap-weighted index and as proof he says that even in the recent environment when value did not out-perform growth fundamental index delivered 1.2% advantage. The last quarter of the article discusses the debt/demographics/deficit crisis, and in the final couple of paragraphs it finally get to emerging markets, where he says that emerging market bonds and stocks are still a good buy, “but global diversification has powerful merits”.

In The Financial Times’“The sobering truth about equities” James Mackintosh writes that bond king Bill Gross, who recently tried to broaden his firm into equities, should be embarrassed for calling the “equity market a “Ponzi scheme””; this is because if equities returned real 6.6%/yr since 1912 while wealth was created (GDP increased) only at a 3.5% rate, “then stockholders were skimming 3% off the top”. Mackintosh argues that this is untrue because: (1) the 6.6% real return occurred only if dividends were reinvested but most investors don’t and excluding dividends the returns were much lower, and (2) “what matters to the economy is total growth in earnings or market capitalisation. What matters to an investor is growth in earnings per share, or in share price” and when new shares are issued they dilute existing shareholders.

And finally, in the Financial Times’“Food for thought on real food issues” Steve Johnson reports that in the debate over whether commodity futures trading is affecting food (and energy) prices, those who are on the affirmative side appear to be winning the argument. And while the definitive evidence proving that speculative investing drives up spot prices is lacking, there is enough concern that should that be the case people will die, that it looks like restrictions on speculative commodity trading are on the way. But Johnson writes that loss of speculative commodity trading is no great loss, as historically commodity related equities had higher returns than futures markets; thus if agricultural commodity were to increase there will be leveraged plays by investing in “food producers, fertilizer companies and farm machinery”. Johnson adds that the other benefit of the restrictions will be when the next rapid rise in food prices occurs after the elimination of speculative commodity trading, politicians will be forced to address the fundamental drivers of higher food prices: growing and wealthier global population, climate change and degraded soil due to overuse.