Topics: Income investments, advisor/planner models and reality, house prices: Canada continues up while U.S. is starting up, cost of cottages, serial refinancing, society improving pension situation? technology revolution in finance? hedge funds? banks encroaching insurance in Canada? gold standard?

Personal Finance and Investments

Jason Zweig in WSJ’s “Will these royal yields rule?” warns that ”royalty trusts” “which collect and distribute income from oil and gas or mining properties, are among the highest-yielding in the stock market, with payouts averaging 9%…Unlike the more-familiar master limited partnerships, which often own or operate energy, mining or other assets, the typical royalty trust holds only the right to receive income from a fixed number of properties… Once the trusts are set up, they are frozen and can’t acquire any new interests to replenish their stream of income… When you see 9% yields in a 1% world, don’t let the word “royalty” fool you into thinking you have just found the king of all income investments.”

In IndexUniverse’s“The darker side of the dividend ETF craze” Hannah Tool writes that “Dividend-focused ETFs are tempting when you hold them up against the insanely low yields on benchmark U.S. government debt. But that doesn’t mean dividend ETFs are a good idea… stocks are not bonds, and thinking you could replace the income portion of your portfolio with dividend-paying stocks in an ETF wrapper just might be the height of folly… Beware the Wall Street marketing machine, and know exactly what you’re getting into”.

In Bloomberg’s“ETFs for income-hungry investors” Lewis Braham reports on “a multi-asset income ETFs that offer a one-size-fits-all solution for income-hungry investors” based on tactical asset allocation from State Street. State Street says clients ask the same two questions: “What could I have done differently during the 2008 credit crisis and what options do I have in this yield-starved environment?” The focus is on total return rather than just yield and “The idea for these funds is not just to invest in income-producing asset classes but to navigate among those classes to bolster returns”. (Good luck to those investing; and quoting the previous article “Beware the Wall Street marketing machine, and know exactly what you’re getting into”.)

Advisors/planners (and clients) might find Pension Research Council’s “Explaining risk to clients: An advisory perspective” an interesting read, where Hogan and Miller use the evolving models for financial planning to discuss the various approaches of how risk is handled with clients. They take the reader through three planning models the: traditional (which assumes that client has a quantifiable risk tolerance and a corresponding level of investment risk can be implemented), rational/life-cycle (where “risk capacity is fundamentally important…limiting losses to a minimum utility level”, “human capital and standard of living take center stage” and wealth is subordinate to lifetime standard of living) and behavioural (“risk assessment and tolerance depend on the frame and can be internally inconsistent”; in addition to framing, human irrationality and loss-aversion are key in decision making process, with a focus on the treatment of risk tolerance, risk capacity and risk perception.) Investment risk management and longevity risk management are handled differently: traditional uses diversification and sustainable withdrawal approach, rational/life-cycle uses hedging/insuring/ALM(TIPS) and annuitization, while behavioral uses guarantees and annuitization with guarantees and upside potential. Then they discuss the influence of these models on the real world planner/advisor experience as they “struggle to bridge the gap between theory and practice”, where “quantitative financial analysis cedes importance to psychology and overall client well-being” and where the process is ongoing, client-centric and the financial planner/advisor having evolved into a financial (or even life) coach/counselor. They “conclude there has been an evolution in advisory practice from a focus on product, to policy, and now increasingly to process, with communication about risk remaining central throughout”.  (This is an interesting article which shines light on the difficulties that real financial planners face on a day to day basis in dealing with real humans, who often  can’t even clearly articulate their financial circumstances and preferences (needs vs. wants).)

Real Estate

According to the July 2012 CanadianTeranet-National Bank National Composite House Price Index house prices were up 0.7% during the month. “The composite gain was exceeded in four of the 11 metropolitan markets surveyed: prices were up 2.0% in Hamilton, Quebec City and Victoria and 1.6% in Toronto. The other seven markets lagged the composite: rises of 0.6% in Ottawa-Gatineau, 0.4% in Edmonton and Montreal, 0.3% in Winnipeg, 0.2% in Calgary and 0.1% in Halifax, with a decline of 0.5% in Vancouver…. In July the composite index was up 4.8% from a year earlier, an eighth consecutive month of deceleration in 12-month inflation.” Toronto. Ottawa and Vancouver were up 9.2%, 2.5% and 1.1% respectively over the past year. (Toronto is driving much of the national increase.)

The June 2012  S&P/Case-Shiller Home Price Indices indicated that “The National Composite rose by 6.9% in the second quarter alone, and is up 1.2% from the same quarter of 2011. The 10- and 20-City Composites closely mimic these results; the 10-City was up 5.8% over the quarter and the 20-City was up 6.0%. The two Composites also entered positive territory on an annual basis, up 0.1% and 0.5%, respectively… We seem to be witnessing exactly what we needed for a sustained recovery; monthly increases coupled with improving annual rates of change. The market may have finally turned around… As of the second quarter of 2012, average home prices across the United States are back at their early 2003 levels.”

In the Financial Post’s “The cottage: is it worth it” Ted Rechtshaffen argues that “for many owners it just doesn’t make financial sense” because they don’t use it enough and refuse to rent it out to cover some of the ‘costs’: property taxes, insurance, major expenses (“new roof or refrigerator”), ‘jobs’ that come with the cottage, wasted time to get there/back, guests “who have overstayed their welcome”, being tied to a location and unable/unwilling to travel elsewhere. And, of course, it is cheaper to rent in most instances. Then there are the potential family conflicts.

In WSJ’s “The serial refinancers” Annamaria Andriotis writes that “Today, lenders say, some borrowers are refinancing when rates drop as little as three-eighths of a percentage point… So what is the catch? In exchange for waiving closing costs, lenders charge a slightly higher interest rate…. a lender typically raises the rate by 0.25 percentage point or more”. For most people this would be a no brainer, for some, expecting to stay in the home and with the mortgage, the 25bp higher rate might turn out to cost more than paying the re-fi costs up front.

In the Financial Post’s “Canada’s hot condo market set to get even hotter” Sunny Freeman reports that according to a new Genworth Canada (a mortgage insurer) study “average condo resale prices are expected to rise next year in seven of the eight metropolitan centres studied” (the exception being Vancouver). The price rise is demand driven from first time buyers and retirees. This is contrary to Bank of Canada view that Toronto is facing a significant oversupply of condos.

Pensions

In Benefit Canada’s “Can society improve its pension situation?” Janet Rabovsky writes that while individuals have levers to pull in trying to right their retirement plans by reducing their standard of living, increasing investment risk or delay their retirement, does society have options to tackle record levels of pension liabilities? She writes that (based on 10% annual savings rate between 20 and 65, real 3.5%/yr return, a 50% replacement rate, and constant real earnings) “Society needs to accumulate (and maintain) pension wealth equal to 4.7 times the total earnings in order to provide sufficient pension savings for its population. Employee compensation accounts for approximately 50% of GDP, which would require the accumulation of pension wealth of around 235% of GDP. Currently…the 11 largest pension markets in the world have pension assets amounting to 72% of GDP (excluding non-pension savings)…” She concludes with the view that “society will struggle to support a retired population in the style to which it aspires unless significant action is taken and unless there is buy-in by society in general”. The WSJ’s “When working until 70 isn’t enough” tackles the same subject when David Wessel reports that according EBRI “retiring at 65 may not be economically possible, either for individuals or society as a whole”, and “for one third of the households working until age 70 won’t be enough to provide adequate income in retirement”.

Things to Ponder

In the Financial Times’“Finance is in need of a technological revolution” Andrew Lo while discussing the much needed technological revolution in finance, mentions Richard Feynman’s comment that “Imagine how much harder physics would be if electrons had feelings” and that finance must contend with not just with the benefits of Moore’s law but also with the curse of Murphy’s law. Given all the recent software crises he concludes with “Financial technology can facilitate tremendous growth. History shows that, when used irresponsibly, it can also lead to great devastation.”

In the Financial Times’ “The hedge funds are playing a loser’s game” Jonathan Ford writes that while many financial industry reputations were trashed in the 2008 crisis but surprisingly hedge funds stayed fashionable, especially with pension funds. Yet “there is little evidence that the industry has the capacity to earn superior returns on the vast ocean of cash it already has at its disposal – let alone all this new money. Even before the financial crisis, results were fairly lackluster and they are worse now.” One of the key problems of the industry is its size which makes it more difficult to find unique strategies and/or to move in/out of the market without affecting prices. While hedge funds represent less than 10% of worldwide invested funds, “they account for a far bigger proportion of all trading on UK and US stock exchanges… The industry is increasingly engaged in a zero-sum game in which one fund’s profit is another’s loss, less the costs of the transaction.” Performance reporting obscures hedge fund performance by using “time-weighted” rather than “dollar-weighted” approach. Pension industry may get an unpleasant surprise.

In the Financial Post’s “RBC ‘defying’ rules banning it from mingling banking, insurance businesses: IBAC” Hugh McKenna reports that  Canada’s insurance brokers attack banks (RBC in particular) in ““defiance” of federal regulations designed to prevent it from mingling banking and insurance activities”. (I struggle with the barriers against competition given the lack of competition in the Canadian financial industry.)

And finally, in the WSJ’s“The gold standard goes mainstream” Seth Lipsky writes that Republican Party’s platform now includes a call “for a new gold commission. The realization that America’s system of fiat money is part of its economic problem is moving from the fringes of political discussion to the center.” There was another gold commission in 1981, which “recommended against restoring a gold basis to the dollar”, however Lipsky writes that in 1981 the” momentum for a new gold standard faded amid successes of the supply-side revolution”. However Mr. Romney indicated that if elected he would be looking for new Fed chairman, presumably one less QE inclined.