Topics: Conflict of interest, private money managers, required assets for retirement, life insurance in retirement? luxury cars? Cap or GDP weighted bond index? replacing Canadian index ETFs? US housing boom in 2015? Gehry’s Toronto condos, flawed data drives up Canada’s house prices, pension fund asset allocation, central banks’ bubble, IMF: Canada’s debt risk, returns/inflation in the eyes of the beholder, Japan debt 200% of GDP and “unintended consequences of “mal investment”, negative nominal rates?

Personal Finance and Investments

In the WSJ’s “Conflict of interest? Moi?” Jason Zweig discusses the difficulty that people have in seeing their own potential conflicts of interest (Dan Ariely writes that Upton Sinclair said “It is difficult to get a man to understand something when his salary depends upon his not understanding it” when he discusses the subject in more detail in his “Disclosure? Not good enough” ) In a study “The financial planners wanted doctors to be barred from accepting gifts from pharmaceutical companies, lest their objectivity be compromised—but thought the same restrictions in their own profession would be unnecessary and onerous.” “The challenge is to defend yourself without being offensive. Never forget to ask your financial adviser: What benefit is there for you in selling this investment to me? And with a kind voice and a smile, ask for the answer in writing.”

In the Financial Post’s“Peeling  back the curtains on private money managers” Michael Nairne writes that on the average ‘private’ money managers have only delivered index-like returns excluding fees, and no guarantee that those who outperformed last year will do so again next year. “The truth is that private money managers, like their mutual fund and institutional brethren, are hard pressed to deliver market-beating performance consistently over time. Neither a marble office nor expensive artwork can safeguard an affluent investor from this simple fact.”

In the WSJ’s “When ‘eight’ isn’t enough” Karen Blumenthal discusses Fidelity’s attempt to define rules of thumb for required retirement assets as a function of age in terms of multiples of annual pay. Given the limitation of their stated assumptions, the benchmarks are: 1x at 35, 3x at 45, 5x at 55 and 8x at 65; for higher income earners the numbers are “way too low” (because Social Security payments cover a smaller proportion of overall needs)! One expert suggested 12x final pay for someone with $150,000 income. Many assumptions come into play including: savings rates, return rates, withdrawal rates, required income replacement rates, years in workforce/saving, etc.

Ellen Schultz in the WSJ’s “Later-life insurance rules” explores whether life insurance is needed after you retire. The short answer for most people is no. For wealthy individuals there might be applications like paying “estate taxes that otherwise would have to be paid by selling investments or illiquid assets at a discount. And if you already own a policy, it can be a very good fixed-income investment…A retiree might assume that even if he begins to pay premiums at an older age, the death benefit will far exceed the premiums he paid over the years. It is true that there’s a windfall if you die early, but if you die late, your heirs will get less than if you had invested the same premiums elsewhere. Your insurer has a far better grasp of the odds than you do. “

In the Financial Post’s “Why you should think about buying that luxury car” Jason Heath writes that “A 35-year old female who opts for a $50,000 car instead of a $25,000 one every seven years through 83 (her life expectancy) is going to spend an extra $25,000 (in today’s dollars) on seven different occasions during her lifetime. As a result, she’s going to go into retirement with $260,480 less at age 60 and needs $93,350 more to fund car purchases in retirement, assuming she could otherwise earn a 5% rate of return on the extra funds. And assuming a generous retirement budget of $68,800 – double the Canadian average according to a 2010 study by Russell Investments – her age 60 retirement could otherwise be age 55 retirement.”

In the Economist’s “The Seoul-Oslo axis” Buttonwood discusses the benefits of a switch from a capitalization to a GDP based bond index. Unlike with stocks where most valued companies are most heavily represent in a cap-weighted index, for bonds the index would be representative of the most indebted countries in the world.

In the Globe and Mail’s“It’s a dog’s life for Canadian index investors”  John Heinzl bemoans the lousy return of Canadian index funds (e.g. XIU), which he attributes to lack of diversification. He then contemplates selling his XIU holdings and replace them with a sector based portfolio or dividend funds or perhaps investing outside Canada but he is concerned about currency risk, or perhaps just a selection of individual stocks. He ends the article soliciting readers’ ideas for a cheap well diversified Canadian ETF. (But it’s the overall portfolio asset allocation that counts, see for example my October 2009 blog entitled   “Asset Allocation II”where I discuss asset allocation in general, the concentration of Canadian market  (financial, energy and materials), how what really counts is overall portfolio diversification and how diversification (e.g. for equity asset class, sectoral, geographical and currency diversification) is improved by foreign/global diversification. When I wrote that blog in 2009 there were no Canadian Vanguard ETFs available, but today they offer a pretty good selection, including some currency hedged ones, which could be used as a good start for well diversified portfolio. )

Real Estate

In the Financial Times’ “A housing boom will lift the US economy” Roger Altman argues that by 2015 we should be seeing a housing boom and according to Barclays “nominal home prices will exceed their 2006 peak”. “This surge will be driven by a combination of improving house prices, a lower inventory of homes for sale, rising rates of household formation and population growth, and improving access to mortgage credit.”

Bloomberg News in “Toronto’s tallest condo designed for a bull market that no longer exists” reports that the proposed Frank Gehry designed and David Mirvish funded Toronto condo towers might be arriving at the wrong time in the cycle. Construction on the first of three towers, with a total of 2600 residential units as well as retail and entertainment space, will start in 2013 when 70% of the units are sold.

In the Globe and Mail’s “Potentially flawed data used by banks and lenders bump up house prices”Robertson and Perkins report that the mortgage insurer CMHC operated database used to “determine how much money can be lent against a residential property…without sending an actual appraiser to the address…(can result)… For home buyers, or homeowners with home-equity lines of credit, an inaccurate valuation by the database could allow them to overpay or borrow much too heavily for the home, industry members argue.” The system essentially indicates whether a house in a particular area is priced within say 10% of similar houses sold in the area without inspecting the specifics of the house or the comparator data points. In effect the system “allows people to pay too much for a property”.

Pensions

In the Globe and Mail’s “Pension fund managers rethink investing model’ Janet McFarland reports that a survey of the world’s pension fund managers indicates that they “are rethinking the traditional way pension money has been managed as many now concede they are unlikely to meet their return targets over the next five years”. According to the survey 60% of Canadian pension funds “either adopted new liability driven investment (LDI) models or are planning to do so. LDI investing involves choosing assets with long time frames – such as real estate or very long-term bonds – that have payouts that match the long-term nature of pension obligations.” (Some might question the timing for this shift from the previously inappropriate 60% stock allocation, used to minimize employer contributions over to past couple of decades, to the more conservative/appropriate LDI model just when bond returns are at historic lows; directionally might make sense as a risk reduction strategy but other risks exist given high bond prices.)The Financial Times covers the same story in “Pensions pessimistic over target returns” where Ruth Sullivan emphasises how many managers in a search for higher returns are shifting to more illiquid assets like real estate and infrastructure (like CPPIB) and emerging market equity and debt.

Things to Ponder

In the Financial Times’“Beware of the ‘central bank put’ bubble” Mohamed El-Erian warns that “the Fed is inserting a sizeable policy wedge between market values and underlying fundamentals. And investors in virtually every market segment – including bonds, commodities, equities, foreign exchange and volatility – have benefited handsomely”.  While “Investors should definitely pay attention to western central banks and respect the market influence of unconventional policies…  (they must keep) a wary eye on how far, and for how long, valuations can be divorced from fundamentals.” You can also read the Economist’s Buttonwood’s take on a related subject in “Lessons from history” where he identified three ways (“inflate, stagnate or default”) to deal with high debt-to-GDP ratio, and central banks’ use of QE and financial repression appear to indicate that they are leaning to the view that “inflation is the least worst way out of the mess”. “The great doubt has always been whether central banks will be able to pull this off, or whether markets will push up nominal interest rates in horror. Of course, the great beauty of QE in this sense, is that central banks can just keep buying bonds and offset private sector sales. But you wouldn’t want to be a small saver in this scenario.”

In the Financial Post’s “Canada’s debt levels a risk to growth: IMF” Gordon Isfeld reports that according to a new IMF report “Things will get a lot worse if policymakers don’t act quickly and decisively…. In Canada, a priority is to limit risks related to elevated house prices and household debt levels.” The article also includes some interesting graphics on “Overview of key economic outlook and history”.

In the Financial Times’ “How do skirts differ from computers” John Kay discusses differences in how return rates are measured (e.g. arithmetic or geometric) and where one or the other might be applicable and he argues that “the relevant measure is specific to the particular purpose you have in mind”. (For returns, arithmetic more appropriate for short-term use and geometric for long-term applications)  The same comments are applicable to the way inflation is measured, with a “basket of goods”; but each month there are sales on some goods, if and how ‘quality improvements’ are factored into prices. “…arcane details of index number construction make a substantial difference to our estimates of inflation and market returns”.

In the WSJ’ “OECD Japan public debt in ‘uncharted territory’” Emsden and Warnock report that according to OECD Japan’s debt has just passed 200% of GDP which could not have been reached had 90% of it had not been held domestically and cost relatively little due to Bank of Japan’s monetary policy. The problem with such a debt level, even under these circumstances, is that there is little room for using fiscal policies for much needed economic stimulus. Sales tax was just increased from 5% to 10% and may have to rise to 15%, Japan has a duality of labour market with older workers the regulars (full-time, protected) and younger workers irregulars (35% of the workforce), and will have to increase immigration due to dwindling dependency ratios. In a related article in the Financial Post’s “The malinvestment crisis” Philip Cross discusses a William White paper on the unintended consequences of “ultra-easy monetary policy”. The collateral damage is mostly domestic and it includes: decreasing ability to affect demand, drives down long-term growth, misallocation of investments (e.g. overinvestment into housing), affect functioning of financial markets, encourages governments not to confront debt problems, “redistribute income and wages in a highly regressive fashion”, “threaten the health of financial institutions” (e.g. insurance companies), and “penalize savers and investors in growth companies, while rewarding debtors and investors in staid dividend-paying companies”. His “conclusion is that monetary policy should be tightened, even at the risk of dampening growth in the short term”.

And finally, in the Globe and Mail’s “Could interest rates fall below zero? Don’t bet against it” Ian McGugan discusses the future of interest rates.  In Europe (e.g. Germany, Denmark, Finland and Switzerland) two-year government rates are below zero; according to some the future might look the same in North America. (By the way they are already negative in ‘real’ terms, and that’s before tax, and that’s what really counts.) But QE driven distortions lead to a confusing situation:  “Negative rates would also spotlight the confusion on display in the markets, where ultra-low bond yields suggest a deflationary future while rising gold prices signal inflationary fears.” The upcoming end of “operation twist” where the fed is buying long-term bonds (to keep long-term interest rates down) and is selling short-term Treasuries (to increase short-term rates), may drive short rates below nominal zero, like in Europe.