Topics: “Glidepath illusion”, ETF costs, Vanguard index changes, investing with dementia, un-indexed SPIAs in decumulation, Canada’s housing slowing, US housing recovery over-rated? “annuity or lump sum”, class action against Nortel pension trustees,  Canadian DB pensions stuck underfunded, longevity insurance pushed by US mutual insurers, “investable rally”? financial industry self-serving, inflation/deflation? Bogle’s new book, “family loan pool”, is unlimited growth over?

Personal Finance and Investments

In Investment News’ “The glidepath illusion” Rob Arnott argues that “the basic premise behind the glide path retirement strategy is flawed”. “Glidepaths feature equity-centric allocations for younger investors transitioning to bond-centric allocations for retired participants. The basic premise of a Glidepath approach is that a systematic increase in the allocation to bonds over time leads to less risk in our planned spending power in retirement.” He compares the glidepath approach with the standard 50/50 stock/bond and what he calls the ‘contrary’ (heavier in bonds when young and lighter when old) and looks at outcomes over the past 141 years from both an assets accumulated and size of annuity that could be purchased perspectives.  Arnott concludes that their performance ranking, starting with highest, is: (1) Contrary (inverse-glidepath), (2) Traditional (50/50) and (3) Glidepath. Some critics may argue that this is “…due to higher real returns for stocks and bonds later in the 141-year period”, which is unlikely to repeat in the future. But Arnott argues that based on his current capital market expectations (historically low yields as the starting point, the inverse glidepath still looks superior to the regular glidepath.  “Our message remains largely unchanged. Investors who are prepared to save aggressively, spend cautiously, and work a few years longer (because we’re living longer), will be fine… But it is entirely secondary whether we choose a Glidepath strategy, an Inverse-Glidepath, or a simple 50/50 rebalanced blend. No strategy can make up for inadequate savings or premature retirement.”

In the WSJ’s “Fee deflation: ETF costs dwindle, but don’t disappear” Jason Zweig asks whether ETF expenses could go to zero given  the cut-throat  price completion under way among ETF providers (Vanguard and Schwab undercutting iShares, see next story). But he warns that the visible annual expenses are not the only ones; other costs to factor in include: tracking error (does ETF consistently and significantly underperform the benchmark?), spread (gap between bid and ask prices when buying and selling), intraday premium that you might pay over NAV when buying an ETF.

In IndexUniverse’s “Vanguard changes tricky for investors”Dave Nadig discusses the just announced Vanguard shift from MSCI (e.g. for VWO and VTI) to FTSE (VWO) and CRSP (VTI) indexes for about half a trillion dollars of the assets they manage. “Vanguard to drop MSCI index on VWO”and“iShares emerges with new ammo in fee war”elaborate more in depth on the shift. The decision s primarily price driven, but implications are somewhat broader. For example the MSCI emerging market index includes Korea whereas FTSE’s does not, since Korea is considered to be a developed country; iShares is staying with the MSCI index. It is reasonable to expect different returns depending on which index is being tracked. With Korea representing about 15% of the MSCI index, once it is gone that will be backfilled by larger allocations to China, India, etc. Some even argue that iShares may benefit from the move as they are the only one staying with MSCI emerging market index, but that is doubtful given the large difference in the MER between VWO and EEM. Vanguard is also shifting other international indexes to FTSE.

In the Globe and Mail’s“Grandpa has dementia, but he is still trading stocks” Linda Stern discusses the impact of declining cognitive capability of older Americans and ways that family should monitor and if necessary insert themselves in the investment decision making process to insure, before it is too late, that assets are not mismanaged or misappropriated by an incompetent or unscrupulous ‘advisor’.  “Of course, more elderly people are ripped off by their relatives than they are by their financial advisers, so the adviser might be as suspicious of you as you are of him. Working together, though, you may be able to calm activity in the account.”

Wade Pfau’s very interesting (though perhaps a touch complex for the non-expert) paper entitled“Efficient frontier for retirement income”suggests that the optimal decumulation approach for a 65 year old couple with a spending goal (in excess of Social Security income) equal to 4% of assets at retirement date adjusted annually for inflation, is a mix of stocks and fixed SPIAs; he was considering the appropriate mix of stocks, bonds, fixed SPIAs, and  indexed SPIAs and VA/GMWBs. This optimum is measured by factoring in lifestyle (here equal to minimum) income as well as desire for leaving an estate, and the SPIA is better than bonds at the 10 percentile of outcomes for all stock/fixed-SPIA allocations. Those who are considering implementing such a strategy might be careful with the potential implications of a few of the assumptions used in the paper: “consistent fee structure for fair comparison between income tools” (though the paper used actual available products on the market (perhaps even the lowest cost source for each category), these may not be those offered or available to all investors in every instance), required income of 4% increasing annually with inflation (retirees’ spending needs are more likely bathtub-like, higher in the first decade of retirement then typically gradually decreasing until perhaps the last couple of years of one’s life when spending might spike again due to medical and assistance with daily living requirements). One would also have to be comfortable with the paper’s capital market expectations and with locking in an annuity under these circumstances. (The other factor one might consider is that annuities are not an investment asset class, but rather an insurance product, and insurance is not free; in fact annuities actually get cheaper with age, so it might make sense if they were only bought if and when they were needed to meet lifestyle (or perhaps even minimum spending) needs, see “Annuity or Lump-Sum (LIF): Upcoming Nortel pensioners’ decision” blog where I suggest such a more dynamic just-in-time and only if needed strategy- annuities can typically be bought until age 85). As usual Pfau, challenges his reader with new perspectives into the difficult decumulation problem, and forces one to reconsider incoming views/prejudices on decumulation strategies. (Thanks to VP for recommending.)

Real Estate

In the Financial Post’s“As housing market slows, industry scrambles to paint positive picture” Garry Marr reports that” Sales plummet in major markets (Vancouver and Toronto) and the industry comes up with a new explanation for the decline, draping its comments with a sense that everything is just fine. The excuses are piling up.”Explanations” for last month’s lower activity include: reduction of amortization period eligible for CMHC insurance from 30 to 25 years, fewer working days in current month compared  to previous month or year, new “more accurate” real estate industry originated home price index which shows lower price declines. As usual, the real estate industry likes to paint a very positive image of price and volume trends, some experts say “ignore what they (the industry) are saying. Sales are plummeting in Toronto and Vancouver. I say get used to this because this is going to go on for a couple of years. Our view is a 25% price decline.”

In Bloomberg’s “Shiller data questions housing revival power: Cutting research” Simon Kennedy reports that according to a new NBER paper “What Have They Been Thinking? Home Buyer Behavior in Hot and Cold Markets”  by Shiller, Case and Thompson “…that while perceptions of short-term price direction have turned positive, long-term expectations continue to weaken. The upshot for Shiller and his colleagues is that while “a recovery may be plausible, and home prices have been rising fairly strongly in recent months, we do not see any unambiguous indication in our expectations data of sharp upward turning point in demand for housing that some observers, and media accounts, have suggested.”

Pensions

Read my new“Annuity or Lump-Sum (LIF): Upcoming Nortel pensioners’ decision” blog I address the “annuity or lump sum?” and as well as the generic “if, when and how much to annuitize?” questions with a discussion of the pros, cons and other qualitative considerations that go into this very personal decision.

In the Globe and Mail’s “Disabled Nortel pensioners launch lawsuit”Jeff Gray reports that former Nortel disabled employees seek “…class-action status on behalf of all Nortel pensioners. It alleges the Canadian branch of Chicago-based Northern Trust Co. and The Royal Trust Co. (part of Royal Bank of Canada) of “acting fraudulently” and “knowingly, intentionally, recklessly and willfully” breached their “fiduciary duties” by leaving Nortel’s health and welfare trust “significantly underfunded.”…The lawsuit alleges the two trust companies wrongly allowed Nortel to remove $32-million from the trust to cover certain employee benefits it was supposed to pay for itself. Plus, the lawsuit alleges, the trust companies allowed Nortel to make contributions to the trust in the form of an “IOU,” rather than cash, amounting to another $28-million shortfall.” (A tip-of-the-hat to the group of disabled employees and Mr. Rochon for pursuing the trustees on these very narrow but very important matters to the disabled group; it would be great to see how the impact of the actions/inactions of trustees, actuaries, investment managers and others involved in the (mis)management of the Nortel pension fund could be challenged with a class action in the broader context of Nortel’s Canadian pension plan. The dramatic failure of the pension plan no doubt had many handmaidens beyond Nortel’s board and executives, who have become immune to legal action due to the settlement agreement effectively imposed by the court. The candidate list of action/inactions to be explored is long and very likely fruitful.)

Barry Critchley in the Financial Post’s “Little improvement in the funded status of Canadian defined benefit pensions” reports that “median solvency funded ratio of a large sample of pension plans has increased from 66% at the end of June 2012 to 68% at the end of September 2012…(and) about 97% of pension plans in this sample had a solvency deficiency as of September 30”.

In the Financial times’ “Charges key to pension outcomes” Skypala and Kelleher report that there is “little academic evidence” to support the argument often heard from pension providers and advisers that “asset management and the potential for outperformance is more important than cost”.

In InvestmentNews’ “Mutual insurers ramp up development of deferred-income annuities” Darla Mercado reports longevity insurance (“Longevity insurance, another name for deferred-income annuities, require clients to pay now for an income stream that they’ll get at least 10 years into the future. The trade-off is that clients run the risk of dying before the income stream begins, only to have their heirs receive nothing.”) offerings from US mutual insurers (New York Life, Northwestern Mutual Life, Symmetra Life and MetLife) are picking up. “A client who ladders certificates of deposit, for instance, isn’t getting an attractive income these days. That customer realizes they need a little more risk, and if they have this annuity covering the back-end risk of longevity, they can take it.” (Valuable product, but it is only available in the US, not Canada.)

Things to Ponder

In the Financial Times’ “There is life in this ‘investable’ rally” Peter Oppenheimer argues that “After years of derating to correct the over-optimistic expectations of the late 1990s, the uncertainty associated with savings and investment rebalancing have left valuations at levels that imply an unrealistically negative scenario, as long as the worst political tail risks can be contained. That is still the “investable opportunity”.” (Let’s hope he is right.)

In the Financial Times’ “Time to change the rules of the game”Pauline Skypala writes that ” It is astonishing how the financial services industry manages to carry on regardless, ignoring or paying lip service to reforms designed to ensure it works for the people whose money it looks after rather than furthering its own interest.” Skypala attacks the (UK) financial industry as being self-serving and continually working to preserve/increase its advantage over its client’s interests. “The answer could be as simple as a legal requirement to fulfill the fiduciary duty providers owe to their clients. Ideally, the investment industry would win back the trust it forfeited long ago…” Also in the Financial Times is “Financial services- the blame game” which reports that “…half of global consumers also have little or no confidence in financial providers… Consumer confidence in the industry is lowest…”

In the Globe and Mail’s “Inflation fears? The real concern should be deflation” Martin Mittelstaedt reports that Gary Shilling says that  “investors should remain on deflation alert, believing that the Fed is only delaying falling consumer price levels through its latest effort at money creation, known as QE3, which was announced early in September. The two previous rounds of quantitative easing, or QE, goosed stocks and commodity returns in the short term, but haven’t altered the fact that global growth is anemic… You get these [QE-induced] spikes in stocks that continue until some shock comes along… that’s when deflation would likely come back to the fore… the Fed’s money-printing hasn’t led to inflation because the private sector is still deleveraging, or paying back debt, which suppresses money creation… Shilling says de-leveraging is likely to continue for another five to seven years. During this period, he believes that rather than seeing inflation, we’re more likely to experience deflation of about 2 per cent to 3 per cent a year.”

In IndexUniverse’s “Invest your time in latest Bogle book” Oliver Ludwig writes that Bogle’s new book “The Clash of the Cultures: Investment vs. Speculation”  is a must read since it is “as much a piece of history as is it a playbook for how to repair financial markets scarred by two bear markets in 10 years and a loss of confidence, is one of those books on finance that ought not be left unread.” For example Bogle opines that “Our ‘Gatekeepers’—the courts, the Congress, the regulatory agencies, the public accountants, the rating agencies, the security analysts, the money managers, the corporate directors, even the shareholders—largely failed in honoring their responsibilities to call out what was going on right before their eyes”. (It’s on my reading list.)

Ron Lieber in the NYT’s “Borrowing from your family, by design” follows up with more details on how one might implement a “family loan pool”, discussing examples on how to raise the necessary funds and the hurdles that those who wanted to borrow from it had to jump over. For example Berry Gordy’s family “…family built a savings fund with $10 monthly contributions from its members. People who wanted to borrow from it had to go before a full family meeting to make the request, and they didn’t get anything without an unanimous vote of approval.” Other examples are given as well.

And finally, in the Financial  Times’ “Is unlimited growth a thing of the past” Martin Wolf discusses Robert Gordon’s challenge to the “…conventional view of economists that “economic growth … will continue indefinitely.” Surprisingly, “For most of history, next to no measurable growth in output per person occurred. What growth did occur came from rising population.” Then productivity increased from mid-18^th century until about 1970, after which it started decelerating. Gordon argued that “growth is driven by the discovery and subsequent exploitation of specific technologies and – above all – by “general purpose technologies”, which transform life in ways both deep and broad”. Good examples of these were the steam engine and railways of the first industrial revolution and “electricity, the internal combustion engine, domestic running water and sewerage, communications (radio and telephone), chemicals and petroleum” which constitute the second industrial revolution. The current third industrial revolution is that of “the age of information, whose leading technologies are the computer, the semiconductor and the internet”.  But Gordon argues that “in its impact on the economy and society, the second industrial revolution was far more profound than the first or the third”. In fact compared to the many “one off” achievements of the second industrial revolution “today’s information age is full of sound and fury signifying little” (Many wouldn’t  argue with that!).  The article also discusses the “reversal of the demographic dividend that came from the baby boomers…” which coincidentally is also the topic the Economist’s “The next crisis: Sponging boomers”.