Hot Off the Web- November 12, 2012

Contents: Prep to meet adviser, Investment Policy Statement ‘essential’, tactical asset allocation failed, skill vs. luck, index wars: watch for under- and over-laps, “rule of 40”, FL property tax Amendment 4- defeated, bleak retirement for young workers, generous public pensions are paid by those with no pensions, cult of equity is dead? Allocate 10-15% to gold? satisfaction with investment sector lower than with used car salesmen, fiduciary advice in Canada, high Shiller p/e suggests low returns? risk reduction: diversification for the long term but only fixed income or cash protects short term, managing digital assets, Obama win might accelerate US regulatory reform, excerpts from Buttonwood’s New York conference.

Personal Finance and Investments

In WSJ’s “Meeting with a financial adviser? Read this first” Aparna Narayanan has some suggestions to consider before going to a financial adviser: “decide what you are seeking” (financial planning, investment management or both), “understand how each adviser is paid” (fee-only: hourly flat-fee or percent of assets under management, or sales commission/trailers or some combination of fees and commissions), fiduciary level of care or potential conflicts of interest from commission based compensation, and what documentation might be required/useful for the first meeting (“paystubs, tax returns, investment records, pension statement, monthly budgets”). If advisor promises market beating returns or you have no chemistry with the prospective adviser, you should look elsewhere.

In the Canadian MoneySaver’s“The ‘essential’ Investment Policy Statement”Warren MacKenzie does a great job explaining the importance/necessity of an IPS (as I have indicated before, if you don’t have an IPS it’s unlikely that you are getting real financial ‘advice’.)

In the WSJ’s “How practical is ‘tactical’?” Jason Zweig writes that “Buy-and-hold is beating dodge-and-weave”. Over the past 1, 3 and 10 years the balanced US portfolio of 60% stocks and 40% bonds returned 11.2%, 10.4% and 6.3% a year, compared to ‘tactical’ funds which returned 6.9% and 4.9% a year over 1 and 3 years respectively, with most of the tactical funds not having been around for the 2008 crash. Zweig adds that of course we have no way of knowing what the future will hold.

In the WSJ’s “Is your manager skillful…or just lucky?”Karen Damato discusses if and how to determine if a manager’s outperformance is a result of luck or skill with Michael Mauboussin, the author of a new book entitled “The success equation: Untangling skill and luck in business, sports and investing” . The article contains a great graphic placing various activities/sports on a line representing a continuum, with outcomes being caused by “pure luck” at one end, all the way to “pure skill”. At or very near the “pure luck” end you’ll find gambling (roulette, one-armed bandit) whereas at the “pure skill” end is chess. Investing is (uncomfortably) close to the “pure luck” end, while sports are somewhere in-between. It doesn’t mean that investment managers are not skilled; in fact, quite the opposite. Mauboussin argues that we have what he calls a “paradox of skill”; “As people become better at an activity, the difference between the best and the average and the best and the worst becomes much narrower. As people become more skillful, luck becomes more important… The reason that luck is so important isn’t that investing skill isn’t relevant. It’s that skill is very high and consistent. That said, over longer periods, skill has a much better chance of shining through. “ (Of course a very-unskilled investment manager over longer periods is more than likely to underperform; The other factor in investments, very often even if you are right you can be wrong if your timing is too early or as the saying goes “you can go bankrupt faster than you can be proven right”.)

I’ve already mentioned last week some of the index changes being introduced by Vanguard. In the WSJ’s “The war between the indexes”Joe Light also points out that investors will have to be more careful when mixing and matching ETFs of different vendors tracking indices from different vendors . One of the more significant changes with Vanguard’s move from MSCI to FTSE is the resulting shift of South Korea from the emerging to developed index. “If an investor holds a developed countries international ETF that follows FTSE indexes and an emerging-markets ETF following the MSCI, for example, he will end up with a huge helping of Korean stocks.” (Or one can end up without any South Korean exposure with MSCI for developed country international index and FTSE for emerging markets.)

In MoneySense’s “Mutual funds: The rule of 40” Jonathan Chevreau writes quotes Malcolm Hamilton on the Rule of 40, a rule of thumb that “a mutual fund investor can take the number 40, divide it by your mutual fund’s Management Expense Ratio (MER), and the result is the number of years it takes management expenses to consume a third of your investment”, i.e. a MER of 2% will consume 1/3 of your investment in 40/2=20 years (I never hear of it, but seems to work; anything to sensitize investors to the importance of costs.)

Real Estate

Florida property tax Amendment 4 pushed by the Florida Association of Realtors was defeated. This amendment was opposed by municipalities and counties as it would further reduce the tax revenue for them. The amendment would have provided property relief for: first time homebuyers, cap property tax assessment increases at 5% instead of current 10% for businesses and non-homestead properties, prevent increase in assessment if property values decrease as in the case of homesteaded properties which are assessed at below market value due to Save-Our-Homes amendment. (This Amendment was very complicated, and by appearing to offer some relief to non-homesteaded property owners was domed. You can read my take last year’s take on the proposed changes in the Florida’s nonhomesteader snowbirds shafted again by new property tax Bill 381” blog. Amendment 4 would have further increased the property tax inequities in Florida; its defeat leaves current bad situation for out-of –state non-homesteaders unchanged, rather than worsening it even further had Amendment 4 passed. You’d think that Florida would want to do almost anything, even encouraging out-of-state property purchasers by offering fair/equal treatment on property taxes.  Imagine headlines like “Florida rolls out red carpet to out-of-state property buyers by eliminating unequal taxation”; it’s an Amendment that would be easy to understand, but it will take more deterioration in Florida’s property market and economy before such a bold (for Florida) move would have a chance of passing.



In the Washington Post’s “Young workers’ retirement grows bleaker amid economic downturn” Michael Fletcher  writes that “The economic downturn is pressing more employers to reduce pension benefits and significantly delaying when people launch their careers, darkening the already bleak picture that young workers face in saving for retirement. Corporations have been slashing pensions for decades, but such cuts are common now in the public sector, where retirement benefits were traditionally much better. In both cases, employers frequently reach for the same tool — preserve benefits for current employees but make severe cuts for new ones.” (The article warns about the coming retirement crisis for the younger generation 20s/30s now trying to enter the workforce; same applies to Canada.)

In the Financial Post’s “Everyone is on the hook for public sector pensions” Dan Kelly, president of Canadian federation of Independent Business, writes that “public pension schemes are unfair to taxpayers and financially unsustainable. While the federal government has partially addressed the fairness issue, much more needs to be done about the large liabilities — and fast… While private-sector pension levels have remained flat, there were 3.14 million Canadians entitled to a public-sector pension as of last year. That’s an increase of 26.6% since 2001 — more than double the rate of growth in private sector employment”.  (While public sector pensions, to a large extent paid for by private s sector employees, may be unfair to private sector employees, bringing everyone to the current state of the private sector’s  failed pension system  is not the answer. What is needed urgently is pension reform, and the PRPP is not it. The answers are simple, e.g. Ontario pension reform: What really needs to be done!but there is just a lack of will to execute.)

Things to Ponder

In the Financial Times’“The cult of equity killed off by pension funds” David Oakley writes that UK pension funds in an effort to reduce volatility and to more closely align assets and liabilities of their maturing schemes are dramatically shifting their allocation from equities to fixed income allocation. This is made particularly difficult in the current low interest rate environment and by their need inflation linked government bonds to better match liabilities. In a survey of UK fund assets the Pension Regulator found 43.2% fixed income and 38.5% equity allocation, the highest fixed income allocation and the first time equity allocation was below fixed income since 2006 when they started keeping records. The author wonders, given the current high prices of bonds, how long such a trend to bonds can continue; an interesting related article is “US corporate bonds-yield of dreams” indicates the some US corporate bonds are perceived as safer than government bonds based on their negative spreads. (No mention where the other 18.3% if the assets were allocated; perhaps other risky assets)

Jim Slater in the Financial Tomes’ “Fearful investors should stock up on gold” writes about a long list of threats and circumstances that might suggest that a 10-15% gold allocation might be appropriate for “fearful investors”. Among the threats and other drivers mentioned are: supply constraints (labour problems and low-grade ore in mining, and central banks no longer sellers of gold), potential middle east war, $16T US debt and other unfunded US liabilities, creditors’ realization that they’ll be repaid in inflated dollars, Euro problems, growing, “international unemployment” among young people in particular, and the “undercapitalization of pension funds” further to be aggravated by the recent more heavy allocation to very low yielding bonds.

In the Financial Times’“Bad tidings for investment sector”Steve Johnson reports that in a 50 sector ranking of consumer satisfaction in the European Union, “books, magazines and newspapers” were at the top and “investments, pensions and securities” were at the bottom of the ranked list; even used car dealers were ranked above the financial instruments. The article suggests some nomenclature/disclosure changes for investment products to improve the disastrous state of distrust of financial products. (I would add that fiduciary level of care by advisors and mutual (customer rather than shareholder owned) organized insurance and investment management corporations would go a long way to increase the trust associated with the financial industry. You can read about some of my thoughts on required changes in the financial industry in the CARP’s “Ideas for an investor friendly financial industry in Canada”.)

You might also be interested in the short BNN discussion, where investor advocate Ken Kivenko and CEO Greg Pollock of Advocis, a Canadian investment advisors’ voluntary association, arguing the pros and cons of requirement in Canada for fiduciary level of care by those claiming to provide financial advice. Pollock argues that advisors already act in the best interest of the clients and a law requiring that would just increase costs, which would be passed on to the client. Ken Kivenko argues that the current “suitability” standard offers no protection to the client when inappropriate advice is provided, and offers the most obvious example of not working in the best interest of the clients in Canada when they are led to the world’s most expensive mutual funds rather than low cost ETFs to implement portfolios. (As I have said before, I have great difficulty understanding how any ‘advisor’ could argue that Canada’s current system of financial advice is not in a dire need for tougher regulation in general and in fiduciary level of care in particular. In Canada anyone can call themselves advisors, the vast majority of time so-called advice is provided without a proper Investment Policy Statement or its equivalent, and investment “products” sold are not in the best interest of the client either because of advisor’s or his employer’s conflicts of interest or because of archaic limitation on what can and cannot be sold by brokers vs. mutual funds salesmen vs. financial planners.)

The Economist’s Buttonwood expresses concerns in “Back to the Shiller p/e” about the high Shiller cyclically adjusted p/e ratio (which “averages earnings over 10 years, and adjust them for inflation”) of the US stock market now at “21.5, well above the historical mean”. In the past, the ten year return on stocks from such a high starting point averaged only real 0.9%. Some skeptics argue that the 2008 crash in earning distort the Shiller p/e, but others argue that pension funds should set expectations at 3% real for 60/40 stock/bond portfolio rather the 8% nominal which many of them assume. Buttonwood concludes that given the relatively high Shiller p/e and very low interest rates today “Absent some unexpected surge in profits (which are already close to an all-time high as a proportion of GDP), the most likely outcome from here is low real returns”, pension funds and individuals saving for retirement better “put more money aside to generate a given pension”.

In Vanguard’s“Dynamic correlations: the implications for portfolio construction”Philips, Walker and Kinniryexplain that while correlation is an important metric for portfolio diversification, it is not static over time, and in particular in a crisis correlations can all move to 1 in a flight to safety.History supports the notion that over longer-term periods, diversification within and across asset classes offers substantial benefit. As a result, investors should continue to focus on their strategic asset allocation with regard to overall risk and return objectives/constraints, and the long-term expected returns, risks, and correlations of the assets in which they invest. For those investors with greater sensitivity to significant near-term loss, lower-risk, lower-returning asset classes such as investment grade bonds or even cash—whose diversifying properties tend to hold up during periods of market stress—may make more sense…(but those) who are willing to endure significant near-term loss in the pursuit of long-term higher returns, may find it reasonable to allow higher risk premium asset classes to play a more substantial role in their portfolios..”

In Journal of Financial Planning’s “Planning for clients’ digital assets” Hopson and Hopson look at “the planning issues and concerns regarding digital assets. Questions that clients need to examine in the event of incapacity or death are explored with possible solutions to address clients’ concerns.” These digital assets include domain names, online accounts (email, bank, broker, social networks, Amazon, online bill payment, electronic bill delivery mechanisms (epost), computers, backup drives and associated domain names, user names, passwords, security questions, etc.

Reuter’s“Wall Street left to rebuild Obama ties after backing Romney” argues that with the Obama re-election Wall Street will not only have to repair relationship with the president, but they must also prepare for a push to execute the still being written Dodd-Frank regulations resulting from  the 2008 crash.  “A 2010 Gallup poll showed that Dodd-Frank was Obama’s most popular law, exceeding healthcare reform…” (Implementation of tighter regulations on financial industry is mostly good news, especially if they finally can execute on uniform requirements for fiduciary responsibility for those claiming to provide financial advice whether they are financial planners, advisers, brokers, insurance salespersons.)

And finally, from the Economist’s  “Buttonwood’s New York conference” a few two-minute video clips on: the Euro crisis, America’s most overvalued asset- the NPV of entitlements, can Europe avoid a lost decade, reforming American entitlements, polarized America, the prospects for America’s economy (This last video is a relatively upbeat/encouraging forecast from Roger Altman on where the US economic growth is heading in the next 2-3 years (a little over 2%, but 4% beyond that.)


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