Contents: Better diversification? Powers of Attorney, why bother with Canadian mutual funds? ETFs to replace mutual funds, US estate tax for Canadians, Shiller: home not an investment, Florida #1 in foreclosures, US vulture fund bondholders of Nortel want quick trial in US, Ottawa inaction on BIA pension priority responsible for Canadian pensioner victimization, impossible for employer to deliver on fiduciary duty simultaneously to pensioners and shareholders, Canadian pension plans can be protected by windup, expanded CPP debate continue but nothing actually ever happens, pension reform in Canada involves risk sharing between employer/employee/government, helicopter money also good for public infrastructure, fund fees must drop due to low expected returns, the “great rotation” is here…or not? P. S. Florida won’t enforce law requiring Canadians to have International Driving Permit

Personal Finance and Investments

Jason Zweig in the WSJ’s “A ‘bucket list’ for better diversification” discusses diversification from a different perspective: “Instead of spreading your bets to protect against a plunge in the U.S. stock market, you should regard your portfolio as a set of bets on basic economic conditions and create one bucket for each: expansion, recession, inflation and deflation.” Traditional diversification ideally would mean that different assets would move together in up-markets and in opposite direction in down-markets; “But history shows you tend to get the exact opposite.” In addition historical correlations are not predictive of future ones. Instead growth and inflation are the basic drivers of financial assets. Instead build four buckets: expansion (stocks, real estate, commodities), recession (bonds), inflation (TIPS and commodities), and deflation (stocks and conventional bonds).  “Instead of constantly sloshing your money around, put some in each bucket and keep it there as lifelong insurance against everyone’s ignorance of the future. Play around the edges every once in a while, if you must. But sticking to basic diversification will give you peace of mind—and probably the last laugh.” (Not sure I’d know how to operationalize that, but it may be worth thinking about the model. As to TIPS for the inflation bucket, the Financial Times’ “US inflation-linked bonds lose lustre”  reports that they are not cheap and  TIPS index had a -1% return in 2013; real TIPS yields are negative and “A lot of investors don’t understand the price risk they face from real yields. Inflation can rise, but you can still lose money on this investment from higher real yields.”)

CARP’s “Helpful information for Ontario residents: Powers of Attorney & substitute decision making” provides links useful resources available from the Office of the Public guardian and Trustee on Powers of Attorney & Substitute Decision Making.

On the subject of Canadian mutual funds for the RRSP season, in one corner is the Financial Post’s “Mutual funds still popular with Canadians, but why?” where David Pett quotes John DeGoey that “We’re creatures of habit, but mutual funds are mostly inferior mouse traps. There are better options out there.” In the other corner is the Globe and Mail’s “It’s time to get over mutual funds’ bad rap” where Rob Carrick writes that “Mutual funds, chosen with care, are just the thing for your RRSP. Funds give you every possible investing category in an easily accessible package that comes with varying levels of advice. Also, the fund industry is no monolith. There are high- and low-cost firms, each with a different way of serving investors and advisers.” (I am with DeGoey/Pett on this one.  Canadian mutual funds have repeatedly been rated as the highest cost funds in the developed world; and even if you get real financial advice (rather than stock or fund picking) with very few exceptions (e.g. Steadyhand which is both highly concentrated and lower than average cost) that one might consider at the margin in the satellite part of a core-satellite portfolio, you’re better off with broadly diversified “plain vanilla” ETFs. By the way, I haven’t bought mutual funds for more than a decade, and got rid of my lingering last F-class fund (which I should have gotten rid off years ago but was reluctant to take the hit on the built-in capital gains) when my online broker called repeatedly that I can no longer hold it in my account. It was a Canadian mutual fund and used the broker’s threat/nudge as an opportunity to finally dump it and promptly replace it with Vanguard’s VCE ETF.)

In IndexUniverse’s “Edelman: ETFs spell end of mutual funds” Ludwig and Voros summarize some of financial advisor Ric Edelman’s thoughts on: mutual funds- will be displaced by ETFs within 15 years (and the US ones are much cheaper than the Canadian ones), on the financial advice business- “Wall Street loves to make money for people who already have money. I want to make money for people who don’t have any…(and) the four fundamentals for running a successful advisory practices, which include: clients must be homogenous; advice must be strategic; advisors must be consistent; and a successful advisor’s operation must be scalable.” In CNBC’s “How investing is just like working at Jiffy Lube” Edelman elaborates that “I’m Jiffy Lube…I’m not going to give you better investments than you can get on your own. I simply save you the time and trouble of having to do it…. I am interested in doing something for 1,000 clients,” he said. “If I can’t do it a thousand times I’m not going to do it at all.” He thinks of his clients as “delegators” to whom he applies a standard formula. (This story is also interesting because here is somebody who built and $8B business on what appears to be mass customization of financial advice.)

In the Financial Post’s “Beware taxes on your US estate” Jamie Golombek discusses how US citizens living in Canada and Canadians (and other non-US citizens/residents) “who own what’s known as “U.S. situs property” may still be caught by the U.S. estate tax. The most common examples of U.S. situs property are U.S. real estate… or shares in U.S. companies, even if they’re held inside Canadian brokerage accounts…” As of January 1, 2013 the US “raised the top estate tax rate to 40% from 35% and it made permanent the US$5-million exemption, indexed to inflation, which means that for 2013, the exemption is now US$5.25-million. Canadians who are not U.S. citizens are allowed a prorated exemption under the Canada-U.S. tax treaty, based on the fraction of the value of their U.S. situs property divided by the value of their worldwide estate… this means if your worldwide estate is under US$5.25-million, you will get a full exemption from U.S. estate tax.”  Golombek also refers to PWC’s Estate tax update: Owning a U.S. vacation home which discusses the implications and available actions for high-net-worth Canadians who die with assets in excess of $5M.

Real Estate

In Business Insider’s “Robert Shiller destroys the idea of investing in a home” Sam Ro reports that in a Bloomberg TV interview “Shiller was reluctant to declare that home prices had bottomed…(and) explained that there wasn’t much reason to believe that home prices would appreciate back to levels seen during the last cycle.” Shiller further argued that “Housing traditionally is not viewed as a great investment. It takes maintenance, it depreciates, it goes out of style. All of those are problems. And there’s technical progress in housing. So, new ones are better… So, why was it considered an investment? That was a fad. That was an idea that took hold in the early 2000’s. And I don’t expect it to come back. Not with the same force. So people might just decide, “Yeah, I’ll diversify my portfolio. I’ll live in a rental.” That is a very sensible thing for many people to do.”

While Bloomberg’s “Foreclosure fillings drop to 6-year low on California law” reports a 28% drop in US foreclosures from 2012 and California lost its first place in foreclosures; in the Palm Beach Post’s “Florida first in foreclosure woe for fifth straight month” Kimberly Miller reports that foreclosure activity, up 64% in January over December and 60% compared to January 2012. This gave Florida the dubious top rank in highest number of foreclosures in January and top foreclosure rate for the fifth month in row. The article notes that this seems inconsistent with recent stories of “increasing home sale prices and dwindling inventories”. One expert quoted indicated that market health can’t return until the distressed properties are cleared and that while Florida prices are unlikely to plummet they “will likely dip before the market rights itself… (and that) those saying the market is getting healthier generally have a vested interest for creating that impression”.

On the other hand in Bloomberg’s “Manhattan new condos raise prices monthly as demand soars” Oshrat Carmiel reports that “Manhattan condo developers, in a construction revival after the credit crisis, are raising prices on their unbuilt units as often as twice a month as buyers return from the housing slump to find there’s little on the market.” (I guess time will tell who is right given that much of the article is also based on ‘vested interest’ real estate agent sourced information. Also we have to keep in mind that according to latest Case-Shiller report covering November 2012, New York prices were down -1.1 %.)

Pensions and Retirement Income

In the WSJ’s “Nortel creditors battle over when to hold trial over cash split” Peg Brickley reports that “US investors (aka vulture funds which bought Nortel bonds at a significant discount and now insist on not only getting 100% of the bond value plus interest for the past four years since bankruptcy- see my “Nortel bondholders poised to get $1.25/dollar while pensioner might get $0.15/dollar?” blog) are pushing to go to trial by the fall over how to divide Nortel Networks Corp. $7.3 billion pile of money, but officials looking out for Canadian and European creditors say the international cash clash could take much longer to sort out.” According to Ernst & Young the monitor of the Canadian insolvency indicates that “there are 2 ½ pages of issues of significant complexity” remaining to be dealt with and cannot completed by the proposed September/October timeframe. (Suddenly the bondholders are in a rush? A couple of weeks ago, according to some sources, their intransigence was the reason for the failed mediation.)

I missed last week Terence Corcoran’s Financial Post article “Pensioners victims of inaction in Ottawa”  in which he lays the blame squarely at the doorstep of  Canada’s Federal government due to its inaction on the BIA changes necessary to provide pensioners priority in bankruptcy when companies fail to meet their duty to adequately fund pension plans. The argument put forward by the government is that “…that if pensions had super-priority status, banks and other lenders might not be willing to lend money to corporations with pension liabilities. As a result, credit availability might suffer and the cost of credit might be “negatively affected.” Such arguments are mostly nonsense, and in any case they amount to a dismissal of — and the sacrificing of — the rights of pensioners and employees for the sake of some greater and hazily defined economic good. If anything, the denial of pensioners of super-priority status creates a moral hazard that encourages companies to underfund pensions.” (Thanks to Ken Kivenko for recommending)

The discussion in the Benefits Canada article “Indalex: Know where to hang your hat” by Mark Firman illustrates the insanity of the employer/administrator simultaneously having fiduciary responsibility to the shareholders and to pensioners as pension plan administrator. How could the conflicting fiduciary duties be simultaneously carried out? It is impossible! Guess who gets shortchanged?

And speaking of conflict of interest in the company’s dual and conflicting fiduciary roles, CARP’s “Pensioners’ rights- Silver lining in Indalex decision?” summarizes some of the good outcomes from the Indalex Supreme Court decision, including that “The Supreme Court confirmed that the deemed trust covers accrued deficiency payments as well as the current contributions. If a company merely winds up the pension plan without going into insolvency or bankruptcy proceedings, then the pensioners’ trust will have priority over the security interests of other secured creditors.” (Therefore Nortel’s management could have protected the pension fund obligations by simply winding up the pension plan before going into first bankruptcy and then insolvency. But Nortel’s management chose not to do that, perhaps intentionally(?) given that Ontario’s “deemed trust” was likely (as confirmed by the Supreme Court) applicable in the Nortel pensioners’ situation. The Ontario regulator also missed the opportunity (responsibility) to have forced windup to protect the pensioners.)

Further to my concerns expressed in the Pensions section of my  Hot Off the Web- February 4, 2013 with at least two of Fred Vettese’s arguments against and expanded CPP, you can read in CARP’s “What’s your problem with CPP/QPP expansion?” Dussault and Kolivakis challenging Mr. Vettese’s  “Five reasons Canada should go slow on CPP expansion”. (As I indicated before I favor a CPP expansion but without assuming the expanded portion should be identical to the existing CPP; it just needs to be built on the CPP administrative infrastructure which is already paid for by the current CPP. For example see my recommendations for a broadening of the CPP described in the Expanded-CPP Plus blog which explores: who pays, level of compulsion, investment vehicles beyond the CPPIB, longevity insurance and fully pre-funding all new benefits.)

Benefit Canada’s “Pension sustainability requires new thinking” discusses Legris and Shapira’s view that “more thought needs to be put into creating retirement plans that will be sustainable in the long term for both plan members and sponsors, and not just a quick fix to reduce risk”. They argue that rather than just shifting the employer risk in a DB plan over to employees in a DC plan is not the answer; instead a more balanced approach is required, where risk is shared by employer, employee and government. Legris mentions the UK as an example where “…adaptive systems in which longevity risk is shared in a more dynamic way…” (While I am not sure what aspect of the UK system he is referring to, I resonate with his view that longevity risk management is a fundamental element of pension reform in Canada, and that Canada has the historical and cultural ingredients of collective responsibility which would be necessary for implementing proper and long overdue pension reform.)

Things to Ponder

Martin Wolf in the Financial Times’ “The case for helicopter money” asks “Why is it good to support the leveraging of private property, but not the supply of public infrastructure? I fail to see any moral force to the idea that fiat money should only promote private, not public, spending”. In his conclusion he opines that “…the view that it is never right to respond to a financial crisis with monetary financing of a consciously expanded fiscal deficit – helicopter money, in brief – is wrong.”

In the Financial Times’ “Fund fees are ‘not sustainable’” Steve Johnson quotes from a Dimson, Marsh and Staunton report that capital markets over the next 20-30 years are expected to deliver real returns of 0.5% on nominal bonds and 3-3.5% on equities compared to 6% between 1980 and 2012 for each. In such an environment fees must go down. (Interestingly the report suggests that Canada and UK were projected to have returns of about 6% over the period but one of the authors questioned its plausibility. Inflation protected government bonds are expected to have negative real returns. John Plender discussing the same topic in the Financial Times’ “Equity expectations hail from cloud cuckoo” added that even though real return on cash is negative ” developed world cash holdings have gone from just over 10 per cent of gross domestic product in 2000 to more than 205 per cent today.” (Does that mean that sooner or later the “great rotation” will be under way as investors won’t be able to resist moving all those assets from low/negative real return cash and bonds into equities? And the answer is…)

And finally, some differing views on the subject of the coming “great rotation”. First McCrum and Watkins in the Financial Times’  “’Great Rotation’ hovers on the horizon” write that in the first four weeks of the new year US stock fund inflow was $21B and globally equity funds had triple the inflow of bond fund funds. Other quoted argue that this is at best a “mini rotation” and that since every investment certificate has to be owned by somebody this is more an indication of where new savings are being directed to; bonds will have to continue their role as diversifier. Furthermore insurance regulation encourage bond holdings and corporate pension have been de=risking their plans with bonds. So the “great rotation” might be somewhat delayed. In the Financial Post’s “Don’t believe everything you hear about the “Great Rotation’” David Rosenberg agrees with those challenging the imminent “great rotation”. He asks “What exactly does a 60-30-10 asset mix (stocks/bonds/cash) really mean when there are more bonds than equities outstanding by a huge margin with respect to supply? Money printing creates illusory wealth and buys time, but if it was truly the answer to a deleveraging cycle, Zimbabwe would be a member of the G10. While there currently are more buyers than sellers in equities, make sure you know the real reason why and where these buyers are coming from (liquidity creation not asset rotation), or you will end up making the wrong decision based on the wrong input…Make your asset allocation decisions based on fundamental analysis… (i.e.) return potential and risks… Having both (stocks and bonds) in a portfolio is the most prudent way of generating risk-adjusted returns.” The Economist’s Buttonwood in “Going with the flow” he quotes Jeffrey Rosenberg that “We ran a Granger causality test on 5 years of monthly stock and bond data. The data clearly indicate that past returns help to predict future flows; past flows show no similar predicted power on future returns”

P.S. In the “Believe it or not” and “No comment required or even possible” category, the National Post reports (and many other Canadian papers, but no mention in Florida papers) that Florida passed a law requiring Canadians (and other foreigners) that to legally drive in Florida they will need an International Driving Permit. The law went into effect on January 1, 2013 absolutely uknown to anyone of the over 3M Canadians (and others) visiting Florida each year. “However, the resulting backlash — some three million Canadians visit Florida a year — left the state scrambling to fix its PR problem, and it issued a statement saying it would not enforce the law.”…no comment.