Contents: Vanguard’s record inflow, index funds beat market with securities lending, some Canadian retirements built on house of cards? RRIF before 71? lessons of unexpected death, retirement pre list, Canada: house sales drop 17% -prices highest in the world-lower house prices would be better, Palm Beach County house prices up 35%-unlikely, mass customization of pensions in a DC world, 401(k)s being drained of funds, Nortel: mediation-not guilty-$643M of estate drained by lawyers and other professionals, inflation alarms, little to show for world’s highest health care spending in the US, real US and UK debt at unrecoverable 800% and 1000% of GDP, Germany repatriating gold from US and France.

Personal Finance and Investments

In the Financial Times’ “Vanguard wins big in price war” Chris Flood reports that Vanguard pulled in $141B new funds in 2012 an asset management industry record which its CEO attributes to low-cost, and “reputation and consistency”.  (Thankfully, and for their own good, more and more people are finally realizing not just the criticality of low cost, but also the advantages of investing in the products of a company owned by the investors in its products, thus eliminating the otherwise essential conflict of interest between investment manager/advisor and investor.)

Jason Zweig in the WSJ’s “Beating the market without even trying” discusses how some index funds (specifically the Thrift Savings Plan run for the US government employees by Blackrock) not only come close to deliver the available market return due to very low cost, but they actually beat the market by sharing with the investor often more than 80% of the fees they collect from securities lending. (Vanguard being mutually structured also returns all securities lending income to investors.)

In the Financial Post’s “Canadians pin retirement dreams on not so safe houses” Andrea Hopkins discusses the some of the risks that many Canadians take when they put most of their retirement eggs in one basket, their home; some don’t even worry about carrying a mortgage into retirement. “Retirees may find it difficult to sell their home in a market that’s softening or to find somewhere affordable to live after selling out. And it’s just risky to assume a single illiquid asset will fund what may be 30 years of retirement.” Some recommend that “For those who find their home to be their most significant retirement asset, I suggest take the current opportunity to downsize, free up the equity, and invest in income-producing investments…” (There are a couple of articles in the Real Estate section below which discuss the slowing homes sales and data which suggests that Canada’s home prices are some of the highest in the world based on some metrics.)

In the Financial Post’s “Look before you make the RRIF leap” Jason Heath writes that “By taking early RRSP withdrawals, even if you don’t need the money to live on, you may pay less tax over the course of your life, for a variety of reasons… most people would be better off in a middle-of-the-road tax bracket for most of their life as opposed to the lowest tax bracket in their 60s and the highest in their 70s and 80s.” It might also preserve their OAS. (This is a difficult decision due to the many variables which affect the outcome like marginal tax rates before they tap their RRSP/RRIF, the size of the RRSP, if they did not tap their RRSP before age 71 then the resulting marginal tax rate when they must make minimum RRIF withdrawals, future changes in tax rates/brackets and required age to convert to RRIF, one’s income relative to where OAS claw back kicks in, the approximate break-even age relative to the ultimate last to die age of a couple, and probably other considerations.)

Ron Lieber in the NYT’s “A shocking death, a financial lesson and help for others” discusses how the suffering of a surviving is spouse aggravated by the list of unfinished “financial tasks that grown-ups are supposed to have finished by the time they approach middle age”. In this case the story of the surviving wife of a 43 year old killed in car-bike accident and the list of challenges includes: location of and access to financial information, not knowing amounts in checking accounts and whether they are sufficient to pay current bills, lack of wills/executors, insufficient life insurance, etc. (Well worth reading, most of us are guilty to various degrees, not the least the case when each of a couple take on different responsibilities and financial matters mostly are run/known to only one of them.)

In WSJ’s “Seven resolutions to get your nest egg in shape” Anne Tergesen lists some important things that must be done to prepare your finances for retirement: track spending, automate savings, plan retirement with spouse, maximize Social Security, minimize taxes, (if appropriate) consider an annuity, and plan for long-term care.

Real Estate

The Financial Post’s “Canadian home sales  slump in double-digit drop year over year” reports a 17.4% drop in Canadian real estate sales. The Canadian Real Estate Association blames the slowdown on the government’s tightening of mortgage lending rules, but…

The Economist’s “Home truths” looks at home price changes and levels in various countries and provide comparative data based on price changes and whether homes are over/under-valued relative to rents and income. The data shows Canada to be by far the most overvalued country as measured by price-to-rent ratio at 78% overvalued, and one the three most overvalued countries (France and Netherlands the other two) in terms of price-to-disposable income ratio at 34% overvalued. The US is 7% and 20% undervalued respectively according to these measures. The over/under-valuation measures are in terms of price-to-rent ratio and price-to-income ratio estimates which are then compared to “fair value” defined as their “long-run average” values.

For those concerned about potentially lower Canadian real estate prices, in the Globe and Mail’s “Why lower home prices are a national priority” David Parkinson reports that a new Bank of Canada study found that high house prices drive not just higher mortgage debt but also higher non-mortgage debt, at least in part due to the “wealth effect”. The report’s authors Kartashova and Tomlin indicated that the 52% rise in home prices between 1999 and 20007 drove 19% increase in non-mortgage debt. The report suggests that to decrease household debt “policy makers are actually going to want a significant downward correction in home prices”. (To some this may sound like fly-swatting with a nuclear device. Also a 25% drop in home prices would represent another wealth transfer from retirees to the younger generation, the other being the financial repression driven low interest rates and underfunded pensions.)

In the unbelievable category, the Palm Beach Post’s “Palm Beach county home price gains top nation in December” Kimberly Miller reports that “According to a report by California-based ZipRealty, Palm Beach County’s median sales price in December was $169,000, up 35 percent from the same time the previous year.” The article notes that the reason might be that inventory dropped sharply and is now about 4.5 month supply and there is increased demand by “by both investors and traditional homebuyers.” (Those on the ground are skeptical of this 35% number.)  One realtor from Jupiter is quoted in the article as saying that “he’s seen an increase in activity and prices, but was skeptical of the 35 percent hike”. (I can echo that.)

Pensions

My just released blog  “Meeting the global challenge of funding retirement- Highlights of Robert Merton’s CFA Institute seminar”  summarizes Nobel prize winning Professor Robert Merton’s approach to tackle some of DC pension plans’ well known but unresolved deficiencies in a holistic manner for the mass/working class pension. He sets the stage by pointing out that, in the shift from DB to DC average workers were by default left with the impossible task to manage their investments by themselves to retirement success. Then, recognizing the reality of an unengaged participant, he proposes a new pension solution which has a goal of maximizing the chance of maintaining inflation protected retirement income close to spending levels in working years while assuring some specified minimum income level. The proposal is a total solution because it takes a goal-based mass customization approach to the retirement income problem using individual accounts; the solution is individually customized as it factors in the individual’s goal, age, and gender and it is a solution to the mass/working class pension as it incorporates all assets/incomes (Social Security, DB pension, DC pension and human capital or future earning potential). The annual feedback to the participant, in the form of the probability of achieving the goal, also comes with three knobs that a little more engaged participant can optionally adjust to increase probability of success: save more, retire later and/or increase risk. No individual financial plan is required, as long as the participants meet the specified profile. While the proposed solution comes without guarantees, one can quickly grasp its superiority over current approaches to DC plans.

In the Washington Post’s “401(k) breaches undermining retirement security for millions” Michael Fletcher reports that “More than one in four American workers with 401(k) and other retirement savings accounts use them to pay current expenses… (they) drain nearly a quarter of the $293 billion that workers and employers deposit into the accounts each year”. To prevent penalties, these withdrawals are typically done in the form of a loan on which interest is paid. “In 2010, 28 percent of participants reported having an outstanding loan against their retirement accounts, an all-time high”. With such very heavy invasion of retirement accounts to meet emergency or even short-term needs, consideration must also be given to perhaps lowering the risk levels for such accounts. Or, some would argue, that it might be appropriate to increase difficulty of making withdrawals.)

Nortel mediation this week and Not guilty of fraud: Though the outcome was inconsequential to Nortel pensioners, many pensioners and ex-Nortel employees read with interest the various articles in the past week reporting on the acquittal of ex- Nortel CEO; these articles, such as  “Verdict recasts sordid history of Nortel Networks” “Nortel never was an Enron” and  “Investors angry, but others expected Nortel acquittal” expressed views on the adequacy of Canada’s anti-fraud actions, on whether investors in Canada’s public companies are adequately protected, on whether Mr. Dunn and colleagues were guilty or not of manipulating Nortel’s financial reports for their personal benefit and whether the witch-hunt against the company was a significant contributor to the extinction of the company. The bottom line is that Judge Morocco ruled, based on the (lack) of evidence presented, that the accused were not guilty. (I couldn’t imagine how any other decision would have been possible without a “smoking gun”. However, this court decision had no bearing on pensioners’ outcomes. Judge Winkler’s mediation activity under way this week is the only one that can ameliorate the pensioners’ plight, given that the federal government refused so far to raise the priority of  pension plan deficits in case of sponsor’s bankruptcy. The argument that pension plans are “deemed trusts” did resonate with the Court in the Indalex decision; this is currently being reviewed by the Supreme Court. But the Indalex circumstances are different from the Nortel ones, and irrespective of the Indalex outcome, the “deemed trust” arguments might still prevail if tested in the Nortel pension plan case. One might be able to understand the differences of opinion among those arguing for or against pursuing this angle in Nortel’s case based on honest differences in legal opinion on the likely outcome given perceived law/precedent, and the cost and time involved in pursuit of such a suit; but one can never forgive the federal government for not stepping into the fray and clarifying the BIA/CCAA to provide the necessary priority to pension plans in bankruptcy, at least over unsecured creditors. Even a suggestion that such a change might be contemplated would have accelerated the mediation efforts now under way.)

And by the way, speaking of Nortel related legal matters, in the Globe and Mail’s “As Nortel pensioners struggle, the lawyers are doing just fine” Jeff Gray reports that since bankruptcy start in 2009 Nortel spent $630M on lawyers accountants and investment bankers and “the meter is still running” with over 100 lawyers representing bondholders and other creditors including pensioners and long-term disabled are spending the week with the mediator Judge Winkler. (Judge Winkler has a monumental task to try to wean the lawyers off from the Nortel through. In the meantime, those pensioners and the long-term disabled who have no other resources will have to go on public assistance. And the federal government continues to be deaf to the necessary BIA/CCAA changes to protect pensioners in Canada, apparently the only developed country (beside Portugal) which has neither pension guarantee fund (except a minimal on in Ontario) nor priority of pension underfunding in case of employer bankruptcy.)

Things to Ponder

In the WSJ’s “Inflation alarms may signal real threat” Spencer Jakab reports that some Fed presidents are starting to warn about long-term inflation. Also Pimco’s Bill Gross warns “that there ultimately will be a cost to today’s money printing. He points out that when the Fed buys $1 trillion a year of Treasurys and mortgage securities, it is akin to financing 80% of the government’s deficit.”

In the Economist’s Daily Chart “Unhealthy outcomes” and Buttonwood’s comment at “The American exception” suggest that the data demands answers. The US has the highest number of deaths among developed countries, except for Denmark,  and a level almost double that of Japan, even though the US has by far the highest spending at almost 18% of GDP, the next highest being Netherlands at 12%. “America has the highest infant-mortality rate of the 17 rich countries examined. Its teenagers are more likely to become pregnant or die from a car accident or violence. Shockingly, deaths among under-50s account for roughly two-thirds of the gap in life expectancy between American men and those in comparable countries. The old fare better. If an American is lucky enough to reach 75, he can expect to live longer than his peers elsewhere.” Buttonwood also struggles with the root cause of some of the US data suggesting that “Perhaps the difference is in primary care; the benefit of a free health service (in other countries) is that no-one is discouraged from visiting the doctor. One of the key factors in the European longevity improvement has been lifestyle changes…. Americans have given up smoking too, but as is well known, their obesity rate has soared. Among the least obese Europeans are the Swiss and the Italians, and they are near the top of the post-65 longevity league. As the saying goes, there are old people and fat people but few old, fat people.” Canada is in the 2^nd quartile spend rate and death rates.

The Economist Buttonwood’s “National balance sheets” discusses a Morgan Stanley “research note on the debt crisis arguing that most developed governments are effectively insolvent… Morgan Stanley reckons the shortfalls are so large (between 800% and 1,000% of GDP in the US and UK) that the situation is hopeless…the public sector must impose a burden on the private sector but the only question is how.”  The unpalatable choices mentioned range from default (Greece) or financial repression (this one is already in progress in most developed countries). So they argue that “With fixed income yields at record lows due to financial repression, we prefer equities over bonds. However, with yields likely to stay low for a long time because of repression, we wouldn’t make a major move out of bonds, as significant losses are unlikely.”

And finally, the Bloomberg’s “Bundesbank to repatriate 674 tons of gold to Germany” and  the Financial Times’ “The meaning of Germany’s gold decision” report and discuss Germany’s decision to “repatriate 674 metric tons of gold from vaults in Paris and New York by 2020 to restore public confidence in the safety of Germany’s reserves… Holdings at the Bank of England will remain unchanged.” In the second of these articles Mohamed El-Erian argues that people shouldn’t be reading too much into such moves, which are likely purely domestically motivated. However if “perceptions of growing mutual mistrusts translate into larger multilateral tensions… (such a move might lead to) greater difficulties resolving payments imbalances and resisting beggar-thy-neighbor national policies.”