Hot Off the Web- September 24, 2012

Topics: Retirement mistakes, non-traded securities, ‘grey divorce’, LTC insurance, BOND vs. BND and AGG, equities for retirees, real estate: Canada slowing while US picking up, US pension plan relief to cost taxpayers, 401(k) problems, Canadian pensions move into alternatives, public pension management: Japan vs. Canada, moving past the DB vs. DC debate, passive vs. active, who benefits from financial ‘engineering’, Bogle: what’s wrong with the financial industry, capital controls on the way? Buttonwood: QE driven future not pretty, Bengen 4% rule is simplistic, investor protection.

Personal Finance and Investments

In Business Insider’s “These nine retirement mistakes are guaranteed to set you back” Bill Losey’s retirement mistakes include: stop working early, underestimating longevity risk and medical expenses, withdrawing too much, ignoring fees and taxes, retiring with debts and having no financial plan for retirement.

In the WSJ’s “Protecting your bucket”Jason Zweig discusses financial advice from radio talk shows, organizing investments into buckets but most significantly about “securities (non-traded REITs  which are bundles of property, in his example) that don’t sell on a stock exchange and typically report their estimated share value once every 12 to 18 months”. “The fact that you don’t see the price changing over time could give you the false impression that a non-traded REIT (or private equity) fund is behaving like a bond, says Jay Hartzell, a finance professor at the University of Texas in Austin.”But although the capital gains—or losses—are delayed, you’ll still be exposed to the underlying performance of the properties”. (The problems of such non-traded assets will also impact Canadians’ public and private pensions with the growing shift in the CCP and other Canadian pension funds toward ‘alternatives’ with similar characteristics- also discussed below in the Pension section.)

In the Globe and Mail’s “Rising ‘grey divorce’ rates create financial havoc for seniors” Linda Nguyen discusses the growing rate of post- age 55 divorce rate and the devastating financial effect it can have on retirement standard of living, especially of women. The root causes mentioned include: high legal costs destroying retirement assets, often lack of women’s experience in handling financial affairs or even awareness of the family’s assets.

In InvestmentNews’ “Health of long-term-care business questionable” Darla Mercado writes that “Long-term-care insurance continues facing pressure on several fronts, particularly as the market consolidates and payouts for in-force contracts rise. The field of LTCI providers is shrinking as companies exit the business or limit their sales…legacy LTCI business puts carriers in a tough spot. Insurers didn’t anticipate insureds living for so long or running up such enormous tabs.” But, the article goes on to say that ”demand is expected to remain high as the people 65 and up face 68% odds that they will become unable to perform at least two activities of daily living or that they will become cognitively impaired, according to data from America’s Health Insurance Plans”. New hybrid products which offer both life and LTC insurance are being promoted by insurance companies but their attractiveness is questioned given that they “have two- to three-year benefit periods and they ultimately require more money upfront…(so) whether hybrid products meet the needs, because the benefit is limited, is still a question”. (Of course the other question the LTCI vendors and their customers may wish to ask is whether given that as indicated above “people 65 and up face 68% odds that they will become unable to perform at least two activities of daily living or that they will become cognitively impaired” is actually a risk suitable to be managed via insurance, as insurance is best suited for low probability high impact risks; given that this is a high probability event (68% suggested above), typical load factors of 50% are associated with LTCI, vendors can increase premiums if they have ‘adverse experience’, benefits are often capped at a few years and tend to cover a small part of actual costs, and policies are non-standardized and opaque, then perhaps LTC risk is more appropriate to manage by saving, i.e. banking the LTCI premia, into a reserve insurance account for this eventuality.)

In’s“Push clients toward equities”Barhat and Shin have a pretty good discussion about the importance of equities as part of the asset allocation even for retirees. (But I am a lot less enthusiastic about their recommendations of “What to buy”.)

In Index Universe’s “Bill Gross: Dump BND &AGG; Buy BOND” Gross argues that his much smaller $2.7B BOND ETF’s 0.55 expense ratio he will have no trouble beating the $15B total US bond market indexed ETFs BND and AGG with expenses of 0.1% and 0.2%, because the much larger funds being indexed must invest 40% in Treasuries earning 0.9%, whereas his BOND ETF has more flexibility (at least until it get larger, as it will). Arnott continued to recommend emerging market bonds.

Real Estate

Canada’s AugustTeranet National Bank House Price Index indicates YoY increase of 4.1% and MoM increase of 0.2%; “the August increase of 0.2% was the smallest August increase in 12 years”. “Vancouver (−1.2%), Victoria (−0.7%) and Quebec City (−0.6%)” were off during the month, while “prices were up from the month before: 2.0% in Hamilton, 0.8% in Ottawa, 0.7% in Toronto and Edmonton, 0.5% in Halifax, 0.4% in Calgary and Winnipeg and 0.1% in Montreal”.

In the Financial Post’s“Housing correction is under way in Canada, ‘soft landing’ likely: banks” John Shmuel reports that according to TD bank “a combination of market fatigue, stricter mortgage lending and a deterioration in housing affordability are behind a slowdown in Canadian home sales. The comments come a day after the Canadian Real Estate Association said home sales fell 5.8% in August from July, and were down 8.9% year over year.” The Bank of Nova Scotia also sees a decline, but no crash, coming. In the Globe and Mail’s “Housing market will crash: research firm” Marin Mittelstaedt reports that Capital Economics forecasts an up to 25% drop in Canadian home prices.

In the Bloomberg’s “Sales of U.S. existing homes climb to two year high”Kowalski and Jaminsko report  that according to the NAR “Purchases of existing houses increased 7.8 percent to a 4.82 million annual rate, the most since May 2010”. In Palm Beach Post’s “Palm Beach County home sales up 8% last month, prices jump 12%” Kim Miller reports that according to the Realtors Association of the Palm Beaches sales are up 8% and prices up 12% in the past year, while single-family home inventory is at five months compared to a normal of six months. Condo sales were up 1% and median sales price was $87,000 up 16%. It appears that Florida Realtors will be releasing a new state-wide home index based on similar principles as the national Case-Shiller index which uses “repeat sales” to calculate price changes. Case-Shiller already includes Miami and Tampa. (Some might be considering realtor sourced indexes potentially tainted based on the last decade’s experience in the U.S. where realtors tended to act as cheerleaders rather than objective observers.)


In the Bloomberg’s “Don’t stick taxpayers with underfunded corporate pensions” the editors argue that the recent rules changes to corporate pensions “will allow companies to underfund their pension plans, which will cost taxpayers down the road…Congress changed the discounting rules, allowing companies to choose discount rates based on a 25-year average of corporate bond yields instead of using an average of just two years… Allowing companies to ignore this fact simply allows them to hide their pension costs and create funding gaps. If a company remains financially healthy, it will have to make bigger payments in later years to catch up, which also means the corporate tax collections boosted by this policy today will be lower in later years. Meanwhile, companies that go bankrupt will tend to have accrued larger unfunded liabilities. The bulk of those liabilities are covered by the Pension Benefit Guaranty Corp., a federal agency backstopped by taxpayers.”

In the NYT’s “Should the 401(k) be reformed or replaced?” Steven Greenhouse writes that while much of the political heat today is centered on Social Security and Medicare, “a quieter, more nuanced debate of large consequence engulfs 401(k)’s, the voluntary, privately financed plans that some see as a savior of American retirement and others see as an impediment: Should 401(k)’s be fine-tuned and expanded or should they be replaced entirely? And for many looking to retirement after the Great Recession, there is this pressing question: What to do about woefully underfunded 401(k)’s now.” Many expert views are discussed on the pros and cons of 401(k)s. John Bogle argues that “the current system is profoundly flawed even as it has moved to the position of pre-eminence in our retirement system”; he “ridiculed how easy it was, despite withdrawal penalties, to take money out of 401(k)’s” and he suggested the use of index funds with fees of about 0.1% instead funds with 2% fees. Many other related topics are discussed such as: low contribution rates, no contributions to the extent of even leaving employer matching funds on the table, appropriate asset allocation, age 50 as a checkpoint where advice might be sought, Ghilarducci’s “Guaranteed retirement Accounts” proposal, the mandatory vs. voluntary participation debate, increasing default participation rate from 3% to 6%.

And Janet McFarland in the Globe and Mail’s “Pension plans see investing opportunities in alternative assets” reports that “A soaring number of Canadian pension plans are shifting their investment strategies this year to embrace real estate and other alternative assets as they struggle to cope with the challenges of a world with entrenched low interest rates.”  Continued low interest rates are driving Canadian pension plans to “alternatives” rather than public equity markets. The problems mentioned in the article include: lack of the necessary expertise to play in these markets (real estate, private equity, hedge funds, etc), their costs (including those of intermediaries)
don’t justify their supposed higher returns. (Other problems not mentioned are that these “alternatives” are less liquid, more difficult to value allowing another degree of freedom for the employer to underfund plans, lower future returns as some of the strategies have low asset capacity and may already be overcrowded and overpriced. And by the way, pension plans are hiding behind low interest rates to try to explain their underfunded status, when recent research has shown that the low discount rate driven rise in liabilities has at least been compensated for by higher asset prices resulting from the same low rates. The real reason for underfunding has in most cases been systematic under-contribution (and contribution holidays)  of the plans which in the short-term benefit shareholders but if the company gets into financial trouble will be paid for pensioners since, unlike other developed countries,  Canadian laws provide no pension protection in bankruptcy.)

Also I just received the latest issue of the Rotman ICPM Journal entitled “Challenging the status quo: New answers to old questions”. Those interested in a more in-depth look at pensions (past, present and future) might find interesting to peruse this issue. A couple of the articles in it were of particular interest to me. Nobusuke Tamaki’s “Managing public pension reserve funds: The case of the Government Pension Investment Fund (GPIF) of Japan” which could have been subtitled the differences in approaches of managing Japan’s (GPIF) and Canada’s (CPPIB) pension systems. The author tables the GPIF: target return=”1.1% above the rate of change in nominal wages” (CPPIB= 4.2% real), asset allocation: 75% bonds/ 20% stock/ 5% short-term (CPPIB= fixed income about 35%), investment management: external/ low cost/ 80% passive/primarily publicly traded securities (CPPIB=internal/higher cost/active/heavy into ‘alternatives’ and non-traded securities). The reasons given to the diametrically opposite approach from the CPPIB include GPIF’s: asset size of $1.4T, high cost/volatility/perceived opaqueness of alternatives and the culturally less acceptable characteristics of these attributes, greater independence from the government of the CPPIB than the GPIF (Not sure if this is a criticism of the Japanese or Canadian approach or just accept the author’s explanation that differences are contextual.) The other interesting article is Keith Ambachtsheer’s “The dysfunctional “DB vs. DC” pension debate: Why and how to move beyond it”in which he tables five principles of sustainable pension design for the 21st Century, and argues that “We can no longer spend precious time debating pension plan designs that are well past their “best before” dates. Fresh thinking brings the fresh design insights the pensions sectors around the world desperately need. Let’s get on with it!”


Coincidentally with the previous GPIF vs. CPPIB comparison, in the Globe and Mail’s “Big returns, little effort: Why indexing is the no fuss way to a smart portfolio” you can read many experts being opining on the superiority of passive vs. active management, even in the case of pension funds. For example “Merton Miller, a 1990 Nobel Prize winner in economics, agrees that indexing is the way to go. He says that “any pension fund manager who doesn’t have the vast majority – and I mean 70 per cent or 80 per cent of his or her portfolio – in passive investments [index funds] is guilty of malfeasance, nonfeasance, or some other kind of bad feasance!””

Things to Ponder

In the Financial Times’ “Outbreaks of cleverness can cost” Pauline Skypala discusses the spread of financial engineering to pensions an effort to limit sponsor contributions necessary to reduce deficits, in the form of “special purpose vehicle”/“contingent liabilities”/using  asset unsellable at desired selling prices/”interest rate swaps”. But Skypala questions whether the value of the ”engineering” work is for the benefit of the “engineer” or shareholder (or even the pensioner), since skeptics might wonder whether the added complexity is to justify consultant fees or increase returns, but the cost when things go wrong will not be borne by the so called “engineers”.

In  Index Universe’s “Bogle: Buy corporate bonds with rates low” Olly Ludwig interviews John Bogle in reference to him new book “The Clash of Cultures: Investment vs. Speculation”. Bogle comments on: fundamental indexing (not really better, has higher volatility and higher turnover- it’s really more of a value and small cap tilt), stocks will outperform bonds, but there are things to worry about like apocalyptic events (15% chance of “Depression, crash, war, famine”) so perhaps add a small amount of intermediate corporate and government bonds into the mix, frustration why it takes so long to implement some of the Dodd-Franks reforms, fiduciary care by advisors and money managers, indexing, ETF trading, size of Vanguard (18% of assets) and the other dominant firms, the need for more real “mutuals” (rather than stockholder owned companies) like Vanguard. By the way John Bogle also has an article in the Financial Times entitled “Fund managers must break their silence” in which he warns against the growing concentration of assets under a few very large managers whom he then slams for not doing an adequate governance job and for having “been conspicuous by their absence from exerting significant influence on the companies that they collectively own”.

In the Financial Times’ “Goldbugs not deterred by Draghi’s superbazooka”John Dizard sees growing European interest in small gold bars and the increasing difficulty of moving deposits from one country to the other within the Eurozone as” the required mechanisms for capital controls are already being put in place. Capital flight will have its wings clipped”.

The Economist’s Buttonwood blog “Friends in low places” looks at the implications of the recent central bank moves in US and Europe and suggests some implications on how the future will likely unfold: “central banks will be huge players in the asset markets in the foreseeable future”, “nominal interest rates are going to be at historic lows for the foreseeable future as well”, the fed’s action had led to the current moral hazard leading to elevated asset prices and in turn to lower savings rates which the lead to lower long-term economic growth rates. Buttonwood predicts that central banks’ independence will be a new constitutional battlefront in the coming years. And just to drive Buttonwood’s point home, in the WSJ’s “Central Banks flex muscles”Lauricella, Reddy and McCarthy report on the “Massive injections of stimulus into financial markets by the world’s largest central banks are creating a domino effect around the globe, prompting governments from Brazil to Turkey to take steps to keep easy money from flooding in and driving up their currencies.” Numerous countries are ramping up the own forms of QE to boost their economies, reduce the cost of servicing their debt, drive up asset prices and attempt competitive devaluations to boost exports. (Is runaway inflation inevitable outcome? If yes, is there any place to hide to protect one’s retirement?)

Wade Pfau has a couple of videos discussing why the “4% rule” (as defined in Bengen’s milestone paper of a couple of decades ago) is simplistic. Regular readers of this blog already know that I am not a fan of the inflexible 4% of initial assets adjusted annually for inflation, come hell or high water, approach. I don’t think that real/rational humans act that way. Nevertheless, Pfau’s factors that can affect “the 4% rule” (e.g. future is unlikely to be like the past, fees and panic selling rather than cool rebalancing, taxes, legacy objectives, asset allocation/classes, Bengen withdrawal strategy likely incompatible required spending profile in retirement) are interesting; by the way this also shows you how complicated a real person’s real life decumulation problem is, why no 20/30/40 year set-and-forget plan is practical and how important spending flexibility is in retirement. (Thanks to VP for recommending.)

And finally, Alberta investor advocate Larry Elford has an interesting website discussing “Solutions, Self defense and best Practices” intended to help his readers protect themselves against “Investment selling malpractice. Systematic methods of robbing Canadians…”


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