Contents: Unfair share of the mutual fund industry, VWO shift to FTSE starts, humans tricked by their minds on compounding, HNWI heavier users of ETFs and ‘core-satellite’ strategies, new Canadian tax numbers, zombie: horror stories of uncompleted US foreclosures, new US mortgage rules, Blackstone buys houses to rent, pension start at 80? UK employers responsible for ‘best’ pension, the not so ‘great rotation’, central bank independence not always the best?

Personal Finance and Investments

In the Globe and Mail’s “How the industry takes an unfair slice of your mutual funds”  Rob Carrick calls his article ‘blunt talk’ about what he describes as “two themes at play here, one of them being the way in which the mutual fund industry has infantilized investors by hiding the cost of investing. The other is the willingness of investors to uncritically accept the fund industry’s fictional world of zero-cost investing. This is pure laziness and it borders on negligence.” He also writes that investors should “Expect to pay for good financial advice, whether it’s through trailing commissions, through a percentage fee based on your account size or through a flat or hourly fee… First, learn the price of everything. Then, judge the value.” (Well worth reading, especially those still holding Canadian mutual funds. By the way, typically advice which does not include some aspect of financial planning is of limited/little value.)

IndexUniverse’s “VWO’s index shift begins with name change” reports that Vanguard’s gradual shift from MSCI to FTSE emerging market index is under way via transitional index to help manage primarily the removal of the 15% South Korea weighting from the index. South Korea exposure will added in a shift from MSCI to FTSE index for VEA Vanguard’s EAFE ETF.

In the WSJ’s “How huge returns mess with your mind” Jason Zweig discusses some flaws of the human mind when he writes that “after a dozen years of bear markets and wrenching volatility, investors need to keep their expectations in check and to avoid taking unacceptable risks in the pursuit of yield… People tend to underestimate how hard it is to earn high rates of return and how much wealth those growth rates would achieve. Because the human mind isn’t very good at appreciating the power of exponential growth, thinking realistically about high returns is hard…” He warns that given the record highs of markets today/recently people should be careful about ratcheting up risk or reaching too far for yield; instead he recommends saving more and increasing your time horizon and let the compounding do the heavy lifting.

In the Financial Post’s ‘How millionaires use ETFs to build ‘core-satellite’ portfolios” Michael Nairne writes that recent surveys indicate that millionaires are more likely to buy ETFs than the less affluent. Also they are more likely to adopt passive investment approaches. However they also use “core and satellite” portfolios, with the “core is comprised of index funds such as ETFs that seek to replicate the returns of an index that reflects the performance of a particular investment market…(while) “Satellite investments offer exposure to asset classes that lack the liquidity needed for an effective indexed solution”. (You might be interested in my 2007 “‘Core-Satellite’ Investment Approach” blog on the subject.)

Jaime Golombek in the Financial Post’s “A new year, a new set of tax numbers” reviews some of the new Canadian tax-related numbers for the New Year. Some of the numbers mentioned that might be of interest to you are: the usual adjustments of income tax brackets and personal exemptions, and OAS/CPP benefit limits, and increased TFSA contribution limit from $5,000 to $5,500.

Real Estate

In the Financial Post’s “The latest US foreclosure horror story; Curse of zombie title” Michelle Conlin describes the true real estate horror story whereby after receiving from a bank notice of foreclosure and sale of their home six years ago and the home owner promptly moved out from the home, he finds out years later that the bank cancelled the foreclosure/sale event and claims to have sent notice to home owner to that effect, which the latter claims never having received. Bottom line is that the home owner finds out that he is now responsible to six years of taxes, being sued by the county for being in violation of housing codes (as a result of vandals/scavengers actions on the abandoned house), being ineligible for government assistance since he owns the house according to records, etc. Welcome to the world of “…the zombie title. Six years in, thousands of homeowners are finding themselves legally liable for houses they didn’t know they still owned after banks decided it wasn’t worth their while to complete foreclosures on them. With impunity, banks have been walking away from foreclosures much the way some homeowners walked away from their mortgages when the housing market first crashed.” With a zombie mortgage “…people have become like indentured serfs, with all of the responsibilities for the properties but none of the rights…” In another Financial Post story “Curse of the zombie title: They bought the house, but still not theirs” Conlin reports that those who unknowingly bought a house with a zombie title ended up buying a house that the bank actually didn’t own “So now, neither did they. The title insurance they were required to have when they closed on the house afforded no protection.” (Sad, but interesting stories if you are not one of the victims involved in this malpractice.)

In the WSJ’s “Rules set for home lenders” Timiraos and Zibel  report on the “New mortgage rules set to be unveiled Thursday by the Consumer Financial Protection Bureau will spell out how lenders must ensure that borrowers can repay their home loans… designed to enhance consumer safety without tightening credit standards beyond current levels… The 2010 Dodd-Frank financial-regulation overhaul changed lending rules to make banks legally responsible for determining that a borrower is able to repay a mortgage… The upshot is that banks are likely to narrow their loan offerings and rely more on the 30-year, fixed-rate mortgage.” (Canadians who typically don’t have access to 30-year mortgages like in the US would have appreciated these in the past and even more so in the future if/when interest rates start going up. Though in the past decade or so, Canadians restricted typically to a maximum of 5-yer mortgage term (not amortization) also had the benefit of very low interest rates. Should rates move up significantly many will be hurt.)

In Bloomberg’s “Blackstone rushes $2.5B purchase as homes rise”  Gittelsohn and Perlberg report that “Blackstone has spent more than $2.5 billion on 16,000 homes to manage as rentals… Blackstone is the largest investor in single-family homes to manage as rentals, acquiring properties in nine markets, from Miami to Phoenix, where prices surged 22 percent in the 12 months through October… It’s bought so quickly it’s “warehousing” more than half of the homes it’s acquired as it completes the purchase and hires staff and contractors to renovate and rent the properties.” In the past Blackstone used to have a “buy, fix and sell” strategy in real estate; the new strategy is expected to generate “revenue and cash flow” in the near term and price appreciation in the longer term.

Pensions

In the Financial Times’ “Study points to state pension at 80” Norma Cohen reports that in the UK the eligible age for state pensions would have to rise to “80 if it wanted to limit payments to the same percentage of workers who lived long enough to receive the benefit when it was launched in 1908…” This is because the odds of a 20 year old living to age 70 have increased from 33% to 80% between 1908 and 2009. “The fairness of increasing the state pension age is obviously a hot topic in many countries, but “Pensions, as originally conceived, were a form of insurance policy against the risk that people might live longer than they were able to earn a living, and fewer than half of them did. But, a century later, large numbers of people receive the benefit for decades.”

Also in the Financial Times is Norma Cohen’s  “Employers must ensure best pension option” where she reports that with the introduction of ‘auto-enrolment’ into pensions the employer is also responsible to ensure that employees have access to or are defaulted to appropriate investment vehicles and/or annuities which give good “value for money”,  are fully transparent on costs and the pension plans have the appropriate governance to prevent conflicts of interest for employer or trustee. (How refreshing! Canada’s pension reforms continue to lag the developed world (despite what you might hear from an annual study from Mercer, which was the actuary of Nortel’s 41% underfunded pension plan); young and old will each pay for this as the day of reckoning is rapidly approaching.)

Things to Ponder

The Economist’s Buttonwood column entitled “Time for the great rotation?”  tackles the question “whether 2013 will be the year of the “great rotation” (as strategists like to call it) out of government bonds and into equities…(since) ” long-term returns from government bonds will be dismal, in real and nominal terms, so stocks are the asset to buy. The relative valuation of equities looks good; the dividend yield in many markets is higher than government bond yields…” However Buttonwood argues that without rapid economic growth (which appears to be the current context” the only levers available to deal with high government and individual debt are “inflate, stagnate or default”. He goes through various scenarios and the likely impact on stocks and bonds and then argues against the likelihood of “…a massive asset reallocation. Pension funds, for example, are heading inexorably towards bond-heavy portfolios as their membership matures and they reduce risk and aim for income; the same approach will be followed by ageing savers all around the developed world. A mini-rotation is more likely.”

And finally, in the Financial Times’ “Fed’s mapmaker charts central bank rethink” Gillian Tett writes that according to new thinking, central bank independence is not necessarily a good thing in all circumstances. After long term debt cycles when both public and private sectors are deleveraging at the same time “there is often deflation and a liquidity trap”. To recover from such situations coordination is required since “Monetary policy and fiscal expansion must both be stimulative, since loose money alone will not work.” In another Financial Times article “Era of independent central banks is over” Stephen King argues that in order to prevent depression level unemployment less central bank independence is increasingly the operating mode. However there is collateral damage such as pension/retirement funding becomes much more expensive under QE/”financial repression” leading to more expensive and lower retirement benefits. So the effect is that “…monetary policy is doing more to redistribute income and wealth than to trigger a rebound in economic activity. Central bankers are making decisions that are more political than economic.” The Economist’s Buttonwood in “Long to reign over us” also discusses central bank independence or lack thereof.